Momentum investing

Updated August 2018

“Momentum investing” and “growth investing” are frequently confused with one another. However, while they share some similarities, they are two distinct strategies.

Growth investing focuses on buying companies that either have strong recent earnings growth, or are expected to have that in the future. By contrast, momentum investing focuses on growth in the share price: a momentum investor buys shares that have gone up the most in the recent past, or are making new 52-week highs, and avoids or even “shorts” those that have done badly.

Some people see momentum investing as little more than a demonstration of the “hot hand” fallacy (this is the idea that because something has had success in a seemingly random event, it is more likely to succeed in the future). The approach has also been blamed for encouraging stockmarket bubbles, as investors buy into rising shares in order to get ahead of future price rises. For example, the 1990s technology boom saw the number of momentum-based funds soar. These funds did very badly when the bull market came to an end in 2000.

Despite this, several studies suggest that the stockmarket does indeed exhibit positive short-term momentum – in other words, stocks that have gone up just keep going up – and that as a result, performance-chasing strategies can work. However, other studies show that over extended periods of time the momentum effect disappears, and that it’s the shares that have seen the greatest declines that are more likely to outperform (which is why many back “value investing” for the long run).

Momentum investing also involves a great deal of trading, which raises costs and eats into returns.