What is momentum investing?
In one paragraph
Momentum investing is a strategy that buys securities with strong recent price performance and avoids or shorts those with weak performance, based on the empirical observation that recent trends tend to persist over the medium term.
What this actually means
Momentum is one of the most replicated anomalies in finance. Studies dating to the 1990s have consistently found that stocks with strong 3–12 month price performance tend to continue outperforming, and stocks with weak performance tend to continue underperforming, over the following months. The pattern holds across asset classes, geographies, and time periods.
The strategy conflicts with the efficient market hypothesis (EMH), which holds that all publicly available information is already priced into securities, leaving no systematic opportunity to earn above-market returns through any rule-based approach. The persistence of momentum returns — documented decades after the pattern was first published — has been one of the strongest pieces of evidence that markets are not perfectly efficient.
Several behavioral explanations compete for the cause. Under-reaction to new information means investors absorb news gradually rather than immediately, creating a drift in prices as the full implication is digested over time. Herding behavior amplifies trends as investors pile into performing assets. These explanations are not mutually exclusive.
Momentum's practical application ranges from simple relative-strength ranking (buying the top-decile performers) to more complex factor-based strategies used by quantitative funds. Retail investors most commonly encounter it as a component of factor ETFs that blend value, quality, and momentum signals.
The key risk is that momentum strategies are subject to sharp reversals — called "momentum crashes" — typically occurring at market turning points when the prior leaders collapse simultaneously. Managing position sizing and diversification is essential.
Andrew Lo's A Non-Random Walk Down Wall Street provides the most rigorous empirical examination of momentum and other market patterns, challenging the EMH through systematic statistical analysis. The Myth of the Rational Market by Justin Fox offers the intellectual history of how the research community processed anomalies like momentum while defending the efficient markets framework. David Dreman's Contrarian Investment Strategies argues from the opposite direction — that contrarianism (buying laggards) beats momentum over longer horizons.
