Momentum is one of the most robust investment factors across centuries of data. Winners continue winning for 3-12 month periods. Losers continue losing. This persistence defies the efficient market hypothesis but is explained by behavioral finance: investors are slow to react to information.
How Momentum Works
Winners outperform because information diffuses slowly. When earnings surprise positively, some investors react immediately, but others take time. Gradual information diffusion creates continued price momentum. Systematic investors who identify and ride this momentum capture the excess return.
Momentum breaks when the cycle reverses. A stock at 52-week highs with strong momentum becomes overbought. Signals of weakness trigger unwind. Sophisticated momentum systems recognize the cycle and exit before reversions.
Measuring Momentum
Relative strength is the foundation. How has security performed relative to its peers or benchmark? 6-month relative strength is a classic momentum measure. 12-month momentum captures longer-term trends. Combining timeframes provides robust momentum signals.
Absolute momentum (return in the past period) combined with relative momentum (vs. peers) creates stronger signals. Positive absolute and relative momentum indicates broad-based strength. Mixed signals require careful interpretation.
Implementation Challenges
Momentum comes with momentum reversals. The same forces that drive trends can reverse them sharply. A stock up 100% in 12 months can drop 50% in three months. Position sizing must account for this binary outcome: either continuation or reversal.
Holding periods matter significantly. Holding momentum winners too long catches reversals. Holding momentum positions 3-6 months typically optimizes return-risk. Longer holding periods increase reversal risk; shorter holding periods miss trend capture.
Momentum Across Asset Classes
Momentum works in stocks, bonds, currencies, commodities. Trend-following systems profitably capture momentum across all liquid markets. Asset class diversification improves momentum robustness. Momentum that fails in stocks might work in currencies.
Crisis periods see momentum breakdown. Flight-to-safety moves can reverse all momentum positions. Momentum systems that survive crises account for these events explicitly through stress testing and regime changes.
Educational content only. Not investment advice.