How to Invest: Momentum Investing

January 19, 2026

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Welcome to How to Invest. In this article:

  • Main Feature: Momentum Investing: Riding the Wave

  • Investment Ideas for All Budgets

  • Educational Corner: Relative vs. Absolute Momentum

  • Did You Know? A Quick Financial Fact

Momentum Investing: Riding the Wave

While Value investors try to "buy low and sell high," Momentum investors follow a different rule: "Buy high and sell higher." This strategy is based on the empirically proven phenomenon that assets performing well tend to continue performing well in the near future, while those performing poorly tend to continue struggling. It applies Isaac Newton’s first law of motion to finance: an object in motion stays in motion. Momentum investing is not about analyzing a company's balance sheet or predicting its future growth; it is about analyzing the behavior of the stock price itself. By identifying strong trends and jumping on board, momentum investors aim to capture the "middle chunk" of a major market move, avoiding the difficult (and often dangerous) task of trying to pick the bottom or the top.

What Is Momentum Investing?

Momentum investing is a systematic strategy that buys stocks that have had the highest returns over the past 3 to 12 months. Key concepts include:

  • Trend Following: The core belief that the market moves in trends, not random walks.

  • The "Lookback" Period: Momentum is typically measured by looking at returns over the last 12 months (often excluding the most recent month to account for short-term reversals).

  • Behavioral Bias: The strategy works because of human psychology. Investors tend to under-react to good news initially (slow price rise) and then over-react as FOMO (Fear Of Missing Out) kicks in (driving the price even higher).

  • Rotation: Momentum portfolios are not static. They require regular "rebalancing" (often quarterly) to sell stocks that have lost steam and buy the new leaders.

Why Invest in Momentum?

  1. Strong Historical Performance: Academic studies, such as those by Jegadeesh and Titman, have shown that the Momentum factor has historically outperformed the broader market over multi-decade periods.

  2. Objectivity: It removes emotion from the equation. You buy a stock because the numbers say it is going up, not because you "like" the product or the CEO.

  3. Adaptability: A momentum strategy naturally pivots to whatever is working. In a tech boom, it owns tech. In an energy boom, it owns energy. You never get stuck holding a "dead" sector for years.

  4. The "Winner" Effect: You are mathematically guaranteed to own the best-performing stocks in the market, because as they rise, they automatically trigger your buy signals.

Risks and Considerations

  1. High Turnover: Momentum strategies require frequent trading, which can generate significant short-term capital gains taxes and transaction costs.

  2. Momentum Crashes: When trends reverse, they can do so violently. Momentum stocks often fall much faster than the broader market during a sudden panic (e.g., the 2009 market bottom, where low-quality "junk" rallied and high-quality momentum crashed).

  3. No Valuation Floor: You are often buying expensive stocks. If the trend breaks, there is no "margin of safety" or dividend yield to support the price.

  4. Difficulty of Execution: It is psychologically hard to buy a stock that has already risen 100% and sell a stock that has just started to fall (admitting a loss).

Building a Momentum Portfolio

  1. Set Your Rules: Decide on your lookback period (e.g., 6 months or 12 months) and your holding period (e.g., rebalance every month or quarter).

  2. Screen for Strength: Sort the S&P 500 or your investable universe by total return over your chosen period.

  3. Filter for Quality: Some sophisticated investors prefer "smooth" momentum (consistent steady rise) over "jumpy" momentum (one massive news spike), as smooth trends tend to last longer.

  4. Cut Losers Quickly: The golden rule of momentum is "Let your winners run and cut your losers short." If a stock drops out of the top rankings, it must be sold immediately.

  5. Diversify: Never rely on a single momentum stock. A basket of 10-30 stocks ensures that one bad earnings report doesn't ruin your portfolio.

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For Small Investors (1 to 100 Dollars)

The "Momentum Factor" ETF Description: Using a dedicated Exchange Traded Fund (ETF) that automatically implements momentum screening rules for a very low fee. Advantages:

  • Professional Execution: The fund manager handles the complex calculations of which stocks to buy and sell.

  • Tax Efficiency: ETFs are structured to minimize the tax hit from the high turnover of stocks within the fund.

  • Instant Diversification: You get exposure to the top ~100 trending stocks instantly.

Limitations:

  • Rebalancing Lag: ETFs typically rebalance only twice a year (semi-annually), meaning they might be slow to react if the market changes direction quickly.

  • Market Beta: These funds are fully invested 100% of the time, so if the whole market crashes, the ETF will crash too.

Implementation:

  • Open a commission-free brokerage account.

  • Purchase a Momentum ETF:

    • iShares MSCI USA Momentum Factor ETF (MTUM): The largest and most popular option.

    • Invesco S&P 500 Momentum ETF (SPMO): Focuses specifically on S&P 500 companies with high momentum.

  • Contribute monthly, regardless of whether the market looks "high" or "low."

For Medium Investors (101 to 10,000 Dollars)

Dual Momentum (Sector Rotation) Description: A strategy popularized by Gary Antonacci. You compare sectors not just to each other ("Relative Momentum") but also to a risk-free asset like cash ("Absolute Momentum"). Advantages:

  • Downside Protection: If the market is crashing, "Absolute Momentum" will signal you to move to cash or bonds, potentially saving you from deep bear markets.

  • Outperformance: By concentrating only on the top 1-3 sectors (e.g., Technology and Energy) rather than the whole market, you can capture higher gains.

  • Systematic: Takes about 15 minutes of work once a month.

Limitations:

  • Tracking Error: Your portfolio will look very different from the S&P 500. You might be flat while the market is up slightly, which can be frustrating.

  • Whipsaw Risk: In a choppy, sideways market, you might get "faked out"—buying and selling constantly for small losses.

Implementation:

  • The Universe: Select 4-5 sector ETFs (e.g., Technology, Healthcare, Financials, Energy, Utilities) and one Bond ETF (AGG).

  • The Rule: On the last day of the month, check the 12-month return of all ETFs.

  • The Check:

    1. Is the S&P 500 return positive? If NO, move 100% to Bonds.

    2. If YES, buy the 1 or 2 Sector ETFs with the highest 12-month return.

  • Repeat monthly.

For Large Investors (10,000 Dollars and Above)

Quantitative "Quality" Momentum Description: Building a custom basket of 20-30 individual stocks that exhibit not just high returns, but consistent returns. This is often called "smooth momentum." Advantages:

  • Sniper Precision: You can filter out "junk" momentum (volatile penny stocks) and focus on high-quality companies with steady institutional buying.

  • Tax Loss Harvesting: With individual stocks, you can sell the losers to offset gains.

  • Avoids ETF Front-Running: Large ETFs (like MTUM) are so big that the market knows what they will buy before they buy it. Doing it yourself avoids this "crowded trade."

Limitations:

  • High Maintenance: Requires running a stock screener and trading monthly or quarterly.

  • Transaction Costs: Even with free trades, the "bid-ask spread" costs money on frequent trades.

Implementation:

  • Use a stock screener (like Finviz or StockRover).

  • Step 1: Screen for the top 10% of stocks by 12-month performance.

  • Step 2: Sort this list by "Volatility" or "% of Positive Days." You want stocks that moved up in a straight line, not a zigzag.

  • Step 3: Buy the top 20 stocks in equal weight (5% each).

  • Step 4: Rebalance quarterly. Sell any stock that drops out of the top 20% and replace it with a new leader.

  • Advanced: Use a "trailing stop loss" (e.g., 15%) on every position to automatically exit if the trend breaks.

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Educational Corner: Relative vs. Absolute Momentum

To be a successful momentum investor, you must understand the two types of momentum:

1. Relative Momentum (The "Race Car" Approach) This compares Asset A to Asset B.

  • Example: "Is Tech performing better than Energy?"

  • Goal: To be in the fastest car on the track.

  • Flaw: Even the fastest car on the track crashes if the whole track collapses (e.g., in 2008, the "best" sector was still down 20%).

2. Absolute Momentum (The "Green Light" Approach) This compares Asset A to Cash (or Zero).

  • Example: "Is the stock market positive over the last year?"

  • Goal: To determine if we should be racing at all.

  • Benefit: This acts as a circuit breaker. If the trend is negative (absolute momentum is bad), you sit in cash.

The Magic: The best strategies, like the "Medium" idea above, combine both. They use Relative Momentum to pick what to buy, and Absolute Momentum to decide when to buy (or when to hide in cash).

Did You Know?

Sir Isaac Newton—one of the smartest humans in history—was a victim of momentum investing gone wrong. In 1720, he invested in the South Sea Company, which was the hottest stock in England. He bought early and made a nice profit of £7,000 (a fortune at the time).

However, seeing his friends continue to get rich as the stock skyrocketed, he succumbed to FOMO (Fear Of Missing Out) and jumped back in near the very top. When the "South Sea Bubble" burst, the trend reversed instantly, and Newton lost £20,000 (millions in today's money). He famously stated: "I can calculate the motion of heavenly bodies, but not the madness of people."

This serves as the ultimate warning for momentum investors: The trend is your friend, until the end when it bends.

That concludes this article of How to Invest. Momentum investing is a powerful tool that challenges the conventional wisdom of "buying low." By respecting the market's wisdom and aligning your portfolio with the trends that are actually happening—rather than the ones you hope will happen—you can capture powerful returns. Whether you use a simple ETF or a dual-momentum system, the key is discipline: the discipline to buy when prices are high, and the discipline to sell when the party is over.