What is Momentum Investing?

Momentum investing is a strategy where investors follow existing price trends and take positions based on whether an asset is moving up or down.

• Investors may take long positions when prices are rising and short positions when prices are falling.
• A 50-day and 200-day moving average may be compared to identify possible trend changes.
• The RSI ranges from 0 to 100. Readings above 70 indicate overbought conditions, while readings below 30 indicate oversold conditions.
• The Stochastic Oscillator also ranges from 0 to 100. Readings above 80 suggest overbought conditions, while readings below 20 suggest oversold conditions.
• Other commonly used indicators include price rate of change and moving averages.
• Momentum strategies generally rely on predefined entry and exit rules, liquidity, trading volume, and technical analysis.

Under momentum investment, investors may take long positions in assets such as ETFs, futures, and stocks when their prices are trending upwards. Short positions may be used when prices are trending downwards.

The basic idea is that an existing trend may continue for some time. Momentum investors therefore try to participate in the trend while it remains strong and exit when their trading rules indicate that momentum is weakening.

For example, suppose a stock has been moving upwards consistently. A momentum investor may buy it while the upward trend remains in place and exit if indicators begin to show that the trend is losing strength.

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Momentum investment usually follows predetermined trading rules. Investors may use technical indicators and other market signals to identify possible entry and exit points.

• Moving averages: Momentum investors may compare moving averages of different periods, such as the 50-day and 200-day moving averages. If the 50-day moving average crosses above the 200-day moving average, it may be treated as a bullish signal. A move back below it may be treated as a bearish signal.
• Sector momentum: A momentum strategy may involve taking long positions in sector ETFs showing stronger momentum and short positions in those showing weaker momentum. Positions may then be changed as price signals change.
• Cross-asset analysis: Some investors may consider signals from other asset classes, such as the Treasury yield curve. For example, they may monitor the relationship between 10-year and 2-year Treasury yields. However, this relationship is not a universal buy or sell signal for stocks.
• Momentum with fundamental factors: Some strategies combine price momentum with fundamental information. The CAN SLIM system, for example, considers factors such as earnings, sales, and price momentum.

For momentum investing, investors generally consider factors such as liquidity, trading volume, security selection, and predefined entry and exit rules.

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Momentum investing remains a recognised investment approach, but its effectiveness is debated. Some investment managers use momentum as part of systematic or active strategies, while others rely more heavily on fundamental analysis.

Fundamental approaches may use methods such as discounted cash flow (DCF) analysis to estimate a company's value. Momentum investing, in comparison, focuses more on price trends and their continuation.

Neither approach can guarantee that an investor will outperform a market index.

Momentum traders can use several indicators to study the direction and strength of price movements. Common examples include price rate of change, the relative strength index, moving averages, and stochastics.

For example, if an RSI reading moves above 70, it suggests that the asset has experienced relatively strong upward price movement. Traders may use this information together with other indicators rather than relying on the RSI alone.

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Market momentum can be calculated using the following formula:

Market momentum = Latest price (V) − Closing price from several days ago (Vx)

Here, Vx is the closing price from x number of days ago.

For example, if you want to measure momentum over a particular number of days, you compare the latest price with the closing price from that earlier date. The difference shows how much the price has moved over the selected period.

Investor behaviour can influence momentum in financial markets. Herd mentality and emotions such as fear and greed may cause many investors to move in the same direction.

For example, when more investors begin buying an asset because its price is already rising, the additional demand may support the upward trend. If sentiment changes, however, selling pressure can cause the price to fall.

Understanding these behavioural factors can therefore help explain why momentum develops and why an existing trend can eventually reverse.

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Momentum investing is a strategy that follows existing price trends. Investors may take long positions in rising assets or use short positions when prices are falling. They use indicators such as moving averages, RSI, price rate of change, and stochastics to study momentum and identify possible entry or exit points. The approach depends on predefined trading rules, security selection, liquidity, and market conditions. However, momentum trends can reverse, so these indicators do not guarantee a particular investment outcome.