Momentum investing turns the classic "buy low, sell high" saying on its head. Instead of selling your best-performing assets, you buy more of them. Your worst-performing assets, on the other hand, are sold off without waiting for them to bounce back from any recent lows.
Here's how you can apply this investment strategy in your portfolio.
What Is Momentum Investing?
Momentum investing is a strategy that states you can maximize long-term profits by riding stocks while they are on a good run and selling them once they’ve had a bad stretch. This strategy flies in the face of many of the most well-known ideas about investing. Essentially, momentum investing is "buying high and selling low" in an effort to beat the overall stock market.
How Does Momentum Investing Work?
Applying momentum investing strategies to your portfolio is easy to do. You just have to pick a time frame to measure, and then assess all the stocks you owned during that time.
Under a common momentum investing scenario, an investor will buy stocks that have had high returns within the past three to 12 months and sell those that have underperformed during that same period.
One drawback of momentum investing is that it can require a good deal of work. Not all investors have the time, energy, or expertise to research which stocks have been on a good run and which have not. This is especially true for more detailed momentum investing techniques, which involve following certain complex technical indicators that tell you when to buy and sell a security.
However, the momentum philosophy can also be applied in a general way. Investors don't need to calculate financial indicators for individual stocks, they can simply put more money into stock index exchange-traded funds (ETFs) when the overall market is doing well. This applies the momentum investing strategy of riding trends in a broader sense.
For those who don't want to do any assessment, there are investment products that follow a momentum approach. Some ETFs allow an investor to easily add momentum investing exposure to their portfolio. Examples include the iShares Edge MCSI USA Momentum Factor ETF (MTUM) and the SPDR Russell 1000 Momentum Focus ETF (ONEO).
History of Momentum Investing
It’s unclear who “invented” momentum investing, but an early example of it could be traced back to 1993. That was the year that researchers noted in the Journal of Finance that, if an investor purchased past winners and sold past losers, they would have received “significant abnormal returns” between 1965 and 1989.
This idea was picked up by Chicago-based fund manager Richard Driehaus about a decade later. In 2004, he told Crain's Chicago Business, “I believe that more money can be made buying high and selling at even higher prices. I try to buy stocks that have already had good price moves, that are often making new highs and that have positive relative strength.”
Momentum Investing Returns
One way to track the success of momentum investing is to look at the MSCI USA Momentum Index, which is designed to emphasize stocks with rising prices. Here’s a look at the annual performance of the MSCI USA Momentum Index compared to its parent index, the MSCI USA Index, as well as the S&P 500.
|Annual Performance of Key Indices|
|Year||MSCI USA Momentum Index||MSCI USA Index||S&P 500|
Past performance is never a guarantee of future returns, but with that in mind, one can form general theories about the patterns of these indices. As you can see, the MSCI USA Momentum Index beat the other two indexes in seven years between 2008 and 2019. However, it is notable that, during the year of the financial crisis in 2008, the index performed worse than other indices. This suggests that momentum investing can add to growth during periods of good stock market growth, but it may fail to protect capital during bad times.
- Momentum investing is a strategy that involves buying securities that are performing well and selling those that are performing poorly.
- Momentum investing is essentially the opposite of the classic "buy low, sell high" saying.
- Some ETFs apply momentum investing techniques, allowing investors to add momentum investing exposure to their portfolio without having to perform any financial analysis.