What Is Momentum Investing?

Momentum investing is the practice of buying assets that have recently performed well and avoiding (or shorting) assets that have recently performed poorly — based on the empirically observed tendency for strong recent performance to continue in the near term.

Unlike value investing (which buys cheap, unloved assets), momentum investing says: buy what's already working. It's counterintuitive to many investors, but decades of academic research across multiple asset classes and geographies confirm that momentum is a persistent, real phenomenon.

The Academic Foundation

Momentum as a systematic factor was formally documented by researchers Jegadeesh and Titman in a landmark 1993 study, and has since been replicated in equities, bonds, commodities, currencies, and real estate around the world. It is widely recognized as one of the core investment "factors" alongside value, size, and quality.

The persistence of momentum is often attributed to two behavioral explanations:

  • Under-reaction: Investors are slow to update their beliefs about a company's prospects after positive news, causing prices to drift upward gradually.
  • Herding and trend-chasing: As a trend becomes widely recognized, more capital flows in, reinforcing the move.

Types of Momentum

Cross-Sectional Momentum (Relative Momentum)

This approach ranks assets against each other and buys the top performers while avoiding or shorting the bottom performers. For example, every month, you invest in the top 20% of S&P 500 stocks by 12-month return (excluding the most recent month to avoid short-term reversal effects).

Time-Series Momentum (Absolute Momentum)

Here, you compare an asset's recent performance against its own history — or against cash. If the asset is above its moving average or has a positive 12-month return, you hold it. If not, you move to cash or bonds. This acts as a powerful risk management tool and tends to reduce drawdowns significantly.

A Simple Momentum Strategy Framework

  1. Universe selection: Define the pool of assets (e.g., global ETFs, sector ETFs, S&P 500 stocks)
  2. Lookback period: Calculate total returns over the past 6–12 months (skipping the most recent month)
  3. Ranking and selection: Select the top N assets or those above a return threshold
  4. Rebalancing: Review and rebalance monthly or quarterly — too frequent and costs eat returns; too infrequent and you miss regime changes
  5. Risk management: Set maximum position sizes, use stop-losses, and consider moving to cash when broad market momentum turns negative

The Critical Risk: Momentum Crashes

Momentum strategies carry a specific risk known as a "momentum crash." After sharp market drawdowns, the assets that fell the most often rebound explosively — crushing short positions in momentum strategies. The most notable momentum crashes occurred during the recovery periods after the 2000 dotcom crash and the 2008 financial crisis.

Mitigation approaches include:

  • Using absolute momentum as a crash filter (moving to cash when market-wide momentum is negative)
  • Combining momentum with value or quality factors to reduce crash exposure
  • Scaling position sizes based on recent volatility

Momentum in a Long-Term Portfolio

For most individual investors, momentum doesn't have to mean active trading. A simple approach is to use ETFs that track momentum factors (available from several major fund providers) within a diversified portfolio. This gives you systematic exposure to the momentum premium without building and maintaining a complex trading system.

Key Takeaways

  • Momentum is one of the most documented and persistent return factors in investing history
  • It works across asset classes, geographies, and timeframes
  • The main risk is sharp reversal ("momentum crashes") during market recoveries
  • A combination of relative and absolute momentum improves both returns and risk management
  • Factor ETFs make momentum accessible to non-programmers

Whether you build a systematic strategy or simply tilt your portfolio toward momentum factors, understanding how and why momentum works will make you a sharper, more disciplined investor.