Momentum Investing
Momentum Investing is the strategy of buying securities that have exhibited strong recent price performance and selling or avoiding those with weak recent performance, based on the empirical tendency for short-to-medium-term trends to persist.
Momentum as a systematic investment factor was formally documented by Narasimhan Jegadeesh and Sheridan Titman in their landmark 1993 Journal of Finance paper, which showed that stocks that outperformed over the prior 3-12 months continued to outperform over the subsequent 3-12 months. The momentum premium — the excess return of a long/short momentum factor — has been one of the most robust anomalies in asset pricing, replicated across US equities, international markets, commodities, currencies, and fixed income.
The existence of momentum directly contradicts weak-form market efficiency, which predicts that past price behavior should have no predictive power for future returns. Several behavioral explanations have been advanced. Underreaction theories argue that investors process information slowly and incompletely, causing prices to drift upward gradually as analysts revise estimates and investors update beliefs following positive earnings surprises. Overreaction theories suggest that momentum is eventually followed by reversal, as initial underreaction gives way to extrapolation and eventual overcorrection.
In US equity markets, the momentum effect has been most consistently observed over 6-12 month formation periods with a one-month skip (to avoid the short-term reversal effect). Cliff Asness, through his work at AQR Capital Management, has been particularly influential in documenting and commercializing momentum as a systematic factor. AQR's research found that value and momentum strategies are negatively correlated, suggesting they work through different mechanisms and combine effectively in a portfolio.
Momentum strategies carry specific risks that pure factor analysis understates. They are subject to sharp and rapid 'factor crashes' — periods such as early 2009 and the post-COVID reopening of 2020 when prior winners collapsed and prior losers surged simultaneously. These crashes occur when the market undergoes a rapid repricing that reverses prior trends, punishing momentum strategies with catastrophic short-term drawdowns.
In practice, momentum-based ETFs and factor funds in the US market allow retail investors to access the premium systematically, though at the cost of periodic severe drawdowns that test conviction and necessitate a long investment horizon.