Strategy Guide
Momentum Investing:
How Price Momentum Works (and Why It Persists)
Momentum investing is the practice of buying assets that have recently risen in price and selling (or avoiding) assets that have recently fallen. The core observation is simple: assets that have outperformed over the past few months tend to continue outperforming over the next few months.
This isn't a new observation. It has been documented by academics for over 30 years and confirmed across every asset class and every period studied. This page explains what momentum investing is, why it works, and how to implement it systematically.
The Academic Case for Momentum
Momentum is one of the most well-documented factors in finance. Here's the evidence that underlies systematic momentum strategies:
Stocks that performed well over the past 3–12 months continue to outperform over the next 3–12 months. This is the foundational momentum paper.
Momentum works across asset classes: equities, bonds, currencies, and commodities, not just stocks. This validates cross-asset momentum rotation.
Momentum is the one anomaly their three-factor model cannot explain. It remains the most persistent and unexplained factor in finance.
Two centuries of data confirm momentum exists across every period, every country, and every asset class studied.
Why Does Momentum Persist?
Economists debate the cause, but the two most credible explanations are:
Behavioral: Investor under-reaction
When positive news hits a sector or asset, investors initially underreact. Prices don't fully adjust immediately. The gradual incorporation of new information creates a trend that momentum strategies can capture. By the time the majority of investors have recognised the trend, prices have already moved significantly.
Structural: Capital flows take time
Large institutional investors can't move capital instantaneously. A fund manager deciding to increase technology exposure must do so over days or weeks. These flows are directional and create sustained price trends that smaller, more nimble investors can follow.
Importantly, both explanations suggest momentum will continue to exist as long as humans, with their inherent cognitive biases and institutional constraints, are participating in markets.
Cross-Sectional vs Time-Series Momentum
Cross-sectional momentum ranks assets against each other and goes long the strongest, short the weakest. This is the "relative strength" approach; you always hold something.
Time-series momentum (also called "trend following") evaluates each asset against its own historical price and goes long only when it's trending up. If nothing is trending up, the strategy holds cash.
The Momentum Capital system combines both: themes are ranked cross-sectionally (relative to each other), but an absolute EMA trend filter prevents entry into themes that are in a downtrend. This hybrid approach captures the best of both: you buy relative strength AND you only hold assets in uptrends.
Momentum Rotation vs Buy & Hold
| Approach | CAGR (2006–2026) | Max Drawdown |
|---|---|---|
Buy & Hold (SPY) Full market exposure at all times. Simple, low-cost. Returns depend entirely on market direction. | 10.80% | -55.2% |
Momentum Sector Rotation Rotates into strong sectors, holds cash when nothing qualifies. Lower drawdown than SPY in bear markets. | 48.62% | -47.3% |
Backtested 2006–2026. Past performance does not guarantee future results.
When Momentum Investing Underperforms
Momentum strategies underperform when market leadership is highly concentrated in a small number of individual stocks rather than broadly distributed across sectors. 2023 is the clearest recent example: nearly all of SPY's gains came from 7 mega-cap tech stocks. A sector-rotation approach that holds XLK (the technology sector) captures some of this, but not the outsized individual stock gains.
Momentum also underperforms at sharp market reversals. When the market quickly rotates from one regime to another, momentum strategies are still positioned for the previous regime and take losses before rotating.
Understanding these failure modes is as important as understanding the strategy itself. 2023 happened. It will happen again in similar conditions. The question is whether the long-run edge compensates for those periods, and over 20 years of data, it does.
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Momentum rankings across all 18 themes are free to view. Full picks with position weights are available on paid tiers. 30-day free trial on Premium.