Momentum investing
Also written Momentum strategy · Trend following · Price momentum investing
An active strategy that rides an ongoing price trend — long in a rising trend, short in a falling one — worked from price and volume data rather than a company's fundamentals.
In plain language
Some managers accept that markets are broadly random, yet still see short stretches where a price keeps moving one way. That stretch may last minutes, or days, or weeks, or months.
A strategy built on the trend carrying on is momentum investing. Go long while the price is rising. Go short while it is falling.
The raw material is price and volume data, not accounts. Volume matters because it shows two things: how much demand and supply there is, and how the crowd is behaving.
The manager does two jobs. She spots the trend, and she judges how strong it is. Then she needs discipline, because the entry and exit levels have to be obeyed exactly.
Not everyone believes in it. Many value managers think the returns are luck.
How it works
The definition (section 18.7). When a portfolio manager's investment strategy is based on the continuation of an ongoing market trend, it is called momentum investing. The manager aims to take a long position in a rising trend and a short position in a declining trend.
Why price-volume data. It is argued to show (a) the demand and supply of the security and (b) the collective behaviour of investors in the market. Besides identifying the trend, the manager also determines its strength. Entry and exit price levels are strictly followed.
The four reasons the workbook gives for its growing prominence:
- it is easy to understand and follow;
- market data is easily available at affordable prices;
- the analysis is agnostic to the security, sector or market, so the analyst does not need expertise across diverse companies, sectors and economies;
- opportunities are identified quickly.
The three objections from value managers: momentum returns are random and by chance; there is no theory to back it up; and it is difficult to convince their own investors.
Momentum also appears as a factor. Section 18.5 lists momentum among the rules used to build smart beta indices — quality, value, volatility, size, momentum — and section 18.5.1's factor table defines the momentum factor as price movement over a period.
No figure is attached. Section 18.7 gives no look-back period, no holding period and no threshold that defines a trend. The only quantities it offers are the qualitative range of trend length: a few minutes to a few days, weeks or months.
A worked example
Illustrative figures — the workbook gives none. Nikhil runs a Rs 1 crore momentum sleeve inside a larger PMS portfolio. His written rules: enter on a 20-day price breakout confirmed by above-average volume, stop loss 5% below entry, target 15% above entry, one position no larger than Rs 20 lakh.
A mid-cap engineering stock breaks out at Rs 480 on volume three times its 20-day average. He buys 4,000 shares for Rs 19,20,000.
| Outcome | Exit price | Proceeds | Result |
|---|---|---|---|
| Target hit | Rs 552 | Rs 22,08,000 | +Rs 2,88,000 |
| Stop hit | Rs 456 | Rs 18,24,000 | −Rs 96,000 |
The sleeve only works if he honours both lines. Selling at Rs 552 when the story feels good, or holding past Rs 456 because the company looks sound, converts a momentum trade into something else — which is exactly why the workbook calls for a great deal of discipline.
Note what Nikhil never looked at: earnings, margins, order book, management. On a momentum signal, fundamentals are not an input.
Why NISM asks about it
Chapter 18, section 18.7 (Momentum Investing), is short and self-contained, which makes it an easy place to set a recall question. Expect: what data momentum investing depends on (price-volume), what position the manager takes in a declining trend (short), and which of a list is a reason for its growing prominence.
It is also examined by contrast. Section 18.5 places momentum among the factors used in smart beta index construction, and section 18.8 sets the growth and value styles against each other — a question can test whether you can tell a momentum strategy from a style.
Common exam traps
- Momentum investing is active, not passive. Rule-based smart beta momentum indices are a different animal: there the rules are fixed in advance and the index is rebalanced periodically.
- It is not growth investing. Growth buys expected earnings growth from fundamental analysis. Momentum buys price direction and does not look at earnings at all.
- Short positions are part of the definition. A strategy that only buys rising stocks is half of what the workbook describes.
- Trend strength matters as much as trend direction. The workbook names both as the manager's job.
- The value manager's criticism is examinable in its own right — returns are random, no theory backs it, and investors are hard to convince. It is a listed objection, not an aside.
Where this is taught
Free preparation for NISM Series XXI-BRelated terms
- Active investingAn investing approach that involves picking individual securities to try to beat the return of the broader asset class, rather than simply tracking it.
- Technical analysisForecasting price direction from past price and volume alone, on the assumption that everything worth knowing about a company is already in its price.
- Market anomalyA pattern of returns that departs from what an asset's fundamentals and risk — as measured by CAPM or another pricing model — say it should earn, and so contradicts market efficiency.
- Smart betaIndex-based investing that deviates from traditional market-cap weighting to emphasise factor exposure such as value, momentum, quality or low volatility. Sits between active and passive.
- Factor modelA model that explains a security's or portfolio's return through its sensitivity to chosen factors — macroeconomic, fundamental or statistical — rather than through a single market beta alone.
- Growth investment styleAn active equity style that buys companies expected to grow faster than their peers, accepts a premium valuation for them, and aims at capital gain rather than income.
- Value investment styleAn investment management style of buying stocks priced below their intrinsic value, on the belief that the market has mispriced them and will correct that mispricing over time.
- Fusion investingA strategy that combines fundamental analysis with behavioural finance: screen for value, filter for financial strength, then pick the stocks showing strong price momentum.
- Random Walk HypothesisThe early form of the efficient market model: security price changes occur randomly, so successive one-period returns are independent and identically distributed.