Momentum Investing Explained: Evidence, Crashes, and Practical Implementation

Momentum investing is among the most extensively documented and debated phenomena in academic finance. The core observation is straightforward: stocks that have performed well over the recent past tend to continue performing well in the near term, and stocks that have performed poorly tend to continue underperforming. Acting on this observation systematically — buying recent winners and avoiding (or shorting) recent losers — has historically generated positive returns in most equity markets examined.

Yet momentum investing is also associated with severe, sudden reversals that have periodically wiped out years of accumulated gains in weeks. Understanding why momentum works, under what conditions it fails, and how to implement it prudently is essential for any sophisticated investor considering factor-based portfolio construction.

This guide is for educational purposes only and does not constitute personal financial advice. The value of investments can fall as well as rise. Past performance of the momentum factor is not a reliable indicator of future performance.

The Academic Evidence

Jegadeesh and Titman (1993)

The landmark academic paper on momentum was published in the Journal of Finance by Narasimhan Jegadeesh and Sheridan Titman in 1993. Their research examined US equity returns from 1965 to 1989 and found that a strategy of buying the top decile of past 6-month or 12-month returners and selling short the bottom decile generated statistically significant returns of approximately 1% per month — or roughly 12% per annum — that were not explained by conventional risk factors.

Their finding was both controversial and robust. It directly challenged the efficient market hypothesis in its semi-strong form, which would predict that past price information is fully reflected in current prices and therefore cannot generate systematic future returns.

Subsequent research replicated the momentum effect across:

• Different time periods (pre- and post-1993, out-of-sample)
• International equity markets (UK, Europe, Japan, emerging markets)
• Asset classes beyond equities (commodities, currencies, fixed income, real estate)
• Different lookback periods (typically 3–12 months, with a 1-month skip to avoid short-term reversal)

The robustness of momentum across so many different markets and asset classes is one of the reasons it has been taken seriously by serious investors — it is not obviously an artefact of data mining in a single market.

Why Does Momentum Persist?

The theoretical explanations for momentum remain unsettled. Risk-based explanations have struggled to convincingly identify what systematic risk momentum investors are compensated for bearing. The most credible explanations are behavioural:

Under-reaction: investors process new information gradually rather than instantaneously. Good earnings news is initially under-reacted to, causing prices to drift upward as the market slowly incorporates the full implications. Momentum strategies capture the drift period.

Herding and positive feedback: once a stock starts rising, momentum-chasing investors — funds tracking trend-following signals, retail investors following recent performance, media coverage amplifying stories — create a self-reinforcing dynamic that continues the trend beyond fundamental justification.

Anchoring and disposition effect: investors are reluctant to crystallise losses (disposition effect) and anchor on past purchase prices, causing them to hold losers too long and sell winners too early. This pattern delays the full price adjustment to information.

Institutional career risk: professional fund managers who buy out-of-favour stocks face short-term career risk if those stocks continue falling before recovering. This creates a systematic tendency to avoid recent losers, reinforcing their underperformance.

Price Momentum vs Earnings Momentum

It is important to distinguish between two related but distinct momentum strategies:

Price Momentum

Price momentum is based purely on past share price returns. The classic cross-sectional implementation sorts stocks by 12-month total return (excluding the most recent month, to avoid short-term reversal effects) and goes long the top quintile while avoiding or going short the bottom quintile. (A related variant, time-series momentum, instead compares each asset to its own past return rather than ranking it against peers.)

Price momentum is purely mechanical and requires no fundamental analysis. It can be implemented systematically at scale and is the basis for most smart beta momentum ETFs.

Earnings Momentum (PEAD)

Post-Earnings Announcement Drift (PEAD) is a closely related phenomenon: stocks that surprise positively on earnings tend to continue rising for weeks or months after the announcement, while negative earners continue to fall. This was documented by Ball and Brown (1968) and has proved remarkably persistent.

Earnings momentum blends quantitative and fundamental inputs. It requires tracking actual versus consensus earnings, revenue beats, and guidance revisions. It tends to be less mechanical than pure price momentum and is widely used by systematic fundamental investors and long/short equity managers.

Some factor investors combine both price and earnings momentum, on the grounds that they capture related but non-identical information, and that their combination produces more stable signals than either in isolation.

Momentum Crashes

The most significant risk in momentum investing is the "momentum crash" — a sudden, severe reversal of momentum positions that can occur with very little warning. Two historical examples are particularly instructive:

2009 Reversal

Following the global financial crisis, momentum strategies had generated strong returns by riding the decline of financial, real estate, and cyclical stocks. When markets abruptly reversed in March 2009, the most-shorted stocks (the prior-year losers) staged violent recoveries, while the long book (prior-year winners, which included defensives and short sellers) fell sharply. Some momentum strategies lost 40–50% in a matter of weeks.

2020 COVID Reversal

The March–May 2020 period saw another severe momentum crash. Momentum strategies had been long in defensive, low-volatility sectors (utilities, consumer staples, healthcare) and short (or underweight) in cyclicals and financials. The subsequent V-shaped recovery concentrated heavily in prior-year losers, inflicting sharp losses on momentum portfolios.

Characteristics of Momentum Crashes

Research by Kent Daniel and Tobias Moskowitz (2016) identified that momentum crashes tend to occur:

• After severe market downturns (when volatility is high and priors about economic direction shift sharply)
• When prior losers have high market beta (meaning they recover sharply when risk appetite returns)
• When momentum has recently been extremely profitable (creating crowded long and short books)

These characteristics suggest that momentum is behaving like a short volatility strategy in some regimes — earning steady positive returns most of the time, but suffering catastrophic losses in specific crisis-and-recovery environments.

Factor Combination: Momentum with Quality and Value

Academic research consistently shows that combining momentum with other factors — particularly value and quality — improves risk-adjusted returns relative to any single factor in isolation. The intuition is that:

• Momentum + Quality avoids the momentum crash risk from holding low-quality cyclicals that happened to be recent winners. Quality screens exclude financially leveraged or low-earnings-quality businesses that are most at risk in a reversal.
• Momentum + Value avoids the deep value trap problem (buying cheap stocks that continue falling) by requiring both cheapness and positive recent price direction before including a stock.
• Momentum + Low Volatility reduces the absolute level of drawdown, at the cost of some return.

AQR Capital Management, one of the leading quantitative asset managers, has published extensively on the benefits of multi-factor diversification, arguing that the correlation between momentum and value returns is materially negative — meaning they tend to perform at different times, and combining them smooths the overall return stream considerably.

Practical Implementation for Sophisticated Investors

Momentum ETFs

A range of ETFs provide systematic exposure to the price momentum factor at low cost:

• iShares MSCI World Momentum Factor ETF: provides global developed market momentum exposure, rebalanced semi-annually
• Invesco S&P 500 Momentum ETF: US-focused momentum exposure
• iShares Edge MSCI UK Momentum Factor ETF: UK market momentum exposure

These products are transparent, cost-effective, and suitable for investors seeking factor exposure without the complexity of direct implementation. Their limitations include relatively infrequent rebalancing (semi-annual or quarterly), which reduces responsiveness to fast-moving momentum signals, and the tendency to be heavily concentrated in whichever sectors happen to lead the market at the time of rebalancing.

Systematic Funds and Managed Futures

For larger allocations, trend-following funds (managed futures) apply momentum principles across a wide range of asset classes — equities, bonds, currencies, commodities — rather than within equities alone. Managers such as AHL (part of Man Group), Winton, and Cantab (now part of GAM) have operated systematic trend-following strategies for decades.

Cross-asset trend following has historically shown low correlation to equity markets in normal environments and, importantly, has tended to generate positive returns during sustained equity bear markets (since it goes short falling markets). This makes it a potential portfolio diversifier, not just a return enhancer.

Access to these strategies typically requires minimum investments of £250,000–£1 million and involves higher fees than index ETFs. They are suitable for sophisticated investors with a genuine understanding of the strategy's characteristics, including its potential for extended drawdowns when markets oscillate without clear trends.

Long/Short Equity Momentum

Some long/short equity hedge funds focus explicitly on earnings momentum and price momentum within equity markets, maintaining net exposures close to zero. These strategies aim to generate absolute returns from the momentum effect, rather than long-only market exposure with a momentum tilt. They are typically accessed through UCITS hedge fund structures or Cayman vehicles, with appropriate minimum investment thresholds.

Risk Management Considerations

Investors implementing momentum strategies should consider:

• Portfolio concentration: pure momentum strategies can become heavily concentrated in a single sector or theme during momentum regimes (e.g., energy in 2022, technology in 2020). Position limits and sector caps help manage this.
• Turnover and transaction costs: momentum requires more frequent trading than buy-and-hold strategies, generating higher transaction costs and tax liabilities. Net-of-cost returns are consistently lower than gross returns in backtests.
• Tail risk hedging: given momentum crash dynamics, some sophisticated allocators buy cheap tail protection (out-of-the-money put options or volatility instruments) specifically when momentum portfolios are heavily crowded.

How Global Investments Can Help

Global Investments works with high-net-worth individuals and families to construct multi-factor portfolios that incorporate momentum alongside value, quality, and other return factors in a genuinely diversified framework. We have access to both systematic ETF-based implementation and institutional-grade managed futures strategies, and we help clients understand the specific risk characteristics of momentum exposure before incorporating it into their portfolio.

We also assist clients with the tax and regulatory dimensions of systematic strategies, which can be significant depending on domicile and jurisdiction of investment.

To discuss whether momentum strategies are appropriate for your portfolio and how they might complement your existing holdings, please contact our advisory team.

This guide is for informational purposes only and does not constitute personal financial advice. The value of investments can fall as well as rise. Past performance of the momentum factor, including historical backtests, is not a reliable indicator of future returns. Momentum strategies can suffer severe losses during market reversals. Please seek qualified professional advice before making investment decisions.