🏄 Investing strategy

Momentum Investing: How It Works, Rules & Example

Momentum investing tilts toward assets that have been rising strongly and away from those that have been falling. It is based on the observed tendency for recent winners to keep outperforming for a while.

IntermediateMedium risk⏳ MonthsBest for: Rules-minded investors comfortable with regular reviews and higher turnover.

How it works

Measure each asset's performance over a lookback period, often 6 to 12 months.
Rank the assets from strongest to weakest.
Hold the top-ranked group, often while skipping the most recent month to reduce short-term noise.
Re-rank on a fixed schedule, such as monthly or quarterly.
Replace assets that drop out of the top group with new leaders.

The rules

EntryBuy assets ranking in the top group by trailing return at each scheduled review.

ExitSell assets that fall out of the top group at the next review, or if they drop below a long-term moving average.

RiskHold a diversified basket rather than one or two names, and accept that momentum can reverse suddenly.

👍 Pros

Rules-based and easy to test.
Captures strong trends while they last.
Can be applied to stocks, sectors, countries or asset classes.

👎 Cons

Sharp momentum crashes can happen when markets reverse quickly.
Frequent turnover can raise costs and taxes.
Requires discipline to follow rankings even when they feel wrong.

Worked example

Example: You track ten hypothetical sector funds. At the quarterly review, the three with the best 12-month returns gained 28%, 24% and 21%, so you split your momentum money equally among them. Three months later one of them slips to sixth place, so you swap it for the new third-ranked fund. Past momentum does not guarantee future gains.

See it on a chart

Demo of the Rate of Change on a simulated price path.

Common mistakes

Chasing assets after huge one-week spikes rather than using a consistent lookback.
Ignoring trading costs from frequent switching.
Abandoning the system after one losing quarter.

Tools for this strategy

📊 Percent Change & Recovery Calculator 📐 Position Size Calculator

Indicators it uses

🏎️ Rate of Change 〰️ Simple Moving Average 💪 Average Directional Index

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FAQ

What lookback period is common?

Many momentum approaches use 6 or 12 months, sometimes skipping the latest month.

Is momentum the same as day trading?

No. Momentum investing usually holds positions for months, not minutes or hours.

Does momentum always work?

No strategy always works. Momentum can suffer sharp losses during sudden market reversals.

Educational only – not financial advice. This page explains ideas and reports the news. It is not a recommendation to buy, sell or hold anything. Markets go up and down and you can lose money. Do your own research and consider talking to a licensed adviser.

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