Momentum Trading
Overview
Momentum trading is a strategy that buys assets showing strong recent performance and sells those showing weak performance, based on the empirically observed tendency for recent winners to continue outperforming and recent losers to continue underperforming over intermediate horizons. This persistence of returns has been documented across equities, commodities, currencies, and crypto markets over decades of academic research.
Key Concepts
Momentum is the tendency for assets with strong recent returns to continue rising and those with weak returns to continue falling. Relative momentum compares an asset's performance against a universe of peers to rank and select the strongest. Absolute momentum evaluates whether an asset's own recent return exceeds a threshold (such as the risk-free rate). Time-series momentum (trend following) and cross-sectional momentum (relative strength) are distinct but complementary strategies. Momentum crashes can occur when crowded momentum positions unwind rapidly, typically during market stress. Look-back periods of three to twelve months tend to produce the strongest momentum signals.
Entry Signals
Enter long positions in the top decile of relative momentum performers over a three to twelve month look-back. Use absolute momentum as a filter — only hold assets with positive recent returns. Enter when rate of change or relative strength indicators confirm price leadership. Initiate positions on pullbacks within a strong momentum trend for better risk-to-reward.
Exit Signals
Exit when an asset's relative momentum ranking falls below a pre-defined threshold. Sell when absolute momentum turns negative, indicating the asset is underperforming cash. Use trailing stops to capture extended momentum runs while protecting capital. Exit immediately during momentum crash conditions indicated by sharp reversals on extreme volume.
Best Timeframes
Daily, Weekly, Monthly
Pro Tips
Momentum is one of the most well-documented and persistent anomalies in financial markets. The greatest risk is the momentum crash — a sudden reversal where recent winners plunge and recent losers surge. Diversifying across multiple assets and using absolute momentum as a risk filter significantly reduces crash exposure. Momentum works best as a systematic, rules-based approach rather than a discretionary one.
More Topics in This Category
Pullback & Retracement Trading
Pullback trading is a trend-following strategy that involves waiting for price to temporarily retrace against the prevailing trend before entering in the trend direction. Rather than chasing breakouts, pullback traders buy the dip in uptrends or sell the rally in downtrends, achieving better entry prices and tighter stop levels. This approach combines patience with trend-following discipline.
Day Trading Fundamentals
Day trading involves opening and closing all positions within a single trading session, seeking to profit from intraday price movements. Day traders rely on short-term technical setups, level-to-level trading, and disciplined risk management to capture multiple small gains throughout the day. This style demands intense focus, fast execution, and strict rules to avoid carrying overnight risk.
Range Trading
Range trading exploits markets that are moving sideways between clearly defined support and resistance levels. Traders buy near support and sell near resistance, capitalising on the predictable oscillation. This style thrives in non-trending conditions where many trend-following strategies struggle, making it a valuable complement to a trader's toolkit.
Contrarian Trading
Contrarian trading involves taking positions against the prevailing market consensus, buying when fear is extreme and selling when euphoria peaks. This approach exploits the tendency for crowd sentiment to reach unsustainable extremes at market turning points. Contrarian traders use sentiment indicators, positioning data, and extreme technical readings to identify moments when the market is likely to reverse.