Momentum Investing

One of the most robust findings in financial research is that assets that have risen recently tend to keep rising in the short term, and assets that have fallen tend to keep falling. This contradicts the "efficient market" view that past prices contain no useful information. Momentum investing is the strategy built on this anomaly — and it has decades of evidence behind it.

Why momentum exists

Momentum persists because of human psychology. Good news about a company gets priced in gradually — not all at once. Investors anchor to old prices, institutional funds have mandate restrictions, and many investors underreact to earnings beats initially, then overreact as the trend becomes undeniable. By the time momentum is obvious, there's still usually runway before it reverses.

Relative strength — the core measure

Relative strength compares a stock's performance against a benchmark or its peers. A stock with high relative strength has outperformed most other stocks over a recent period (typically 3–12 months). Momentum strategies typically go long high relative strength stocks and short (or avoid) low relative strength ones.

MACD — Moving Average Convergence Divergence

MACD is the most widely used momentum indicator. It tracks the difference between a 12-day and 26-day exponential moving average (EMA) of price. When the faster 12-day EMA crosses above the slower 26-day EMA, it's a bullish signal — short-term price is accelerating above longer-term trend. The "signal line" (9-day EMA of MACD) triggers entries and exits. A MACD crossover above zero is considered a buy signal; below zero, a sell signal.

The momentum crash problem

Momentum strategies work well in trending markets and fail catastrophically in sharp reversals. In March 2020, the COVID crash caused one of the worst momentum crashes on record — high-momentum stocks (most of which were in sectors that had benefited from the prior trend) fell harder and faster than everything else. Momentum strategies can be in the wrong stocks at exactly the wrong moment.

Research suggests momentum works best when combined with other factors — quality filters (avoiding highly leveraged companies) and volatility limits reduce the crash exposure significantly.