Momentum investing, in its simplest form, is the idea that stocks which have been going up are likely to keep going up, and those sliding down the slope may continue to do so. It’s like surfing: you catch the wave and ride it until it fizzles out. Unlike the classic value investing where you buy boring companies waiting for them to wake up, momentum investing thrives on action, trends, and investor psychology.
Momentum exists because markets aren’t perfectly efficient; investors are humans. People become greedy, fearful, and overly attached to recent news. When earnings surprise on the upside, or a sector suddenly becomes the apple of everyone’s eye, prices can keep moving in that direction for weeks, months, or even years. Behavioural biases, such as herding and the disposition effect (selling winners too early and holding losers too long), create fertile ground for momentum. By being systematic, buying the winners and selling the losers, you exploit these very biases.
There are two main flavours: price momentum and earnings momentum. Price momentum is the classic: look at how a stock’s price has performed relative to the market over various time frames. Stocks outperforming their peers could have underlying strength—be it strong demand for products, sector tailwinds, or sheer investor excitement.
Earnings momentum digs deeper: it’s about identifying companies with consistent positive earnings surprises or upward revisions in analysts’ forecasts. This often leads to sustainable trends since improving fundamentals support the rally, reducing the risk of abrupt reversals you might see in price-only momentum plays.
A key benefit of momentum investing is the tendency for trends to persist longer than most expect. Think of it like a train: once it picks up speed, it doesn’t stop instantly. Look at sectors like pharma post COVID-19 pandemic. Earnings turned around, and the price moves followed for years. But don’t confuse persistence with permanence. When the environment changes due to new regulations, tech disruptions, or unexpected crises, the momentum can break sharply.
Momentum investing forces you to focus on what’s working now rather than what should work eventually. While value investors might buy lagging stocks with the expectation for a turnaround, momentum investors cut their losses. This discipline helps avoid ‘value traps,’ i.e., stocks that appear cheap and remain so forever. Instead, you sell what’s falling and redeploy into stocks gaining strength.
Perhaps the most fascinating feature of active momentum investing is its adaptability. When markets favour growth, momentum portfolios tilt towards fast-growing companies. When uncertainty strikes, momentum shifts towards defensives or quality names. It’s like an automatic transmission in your car: it shifts gears as needed without manual intervention.
Passive momentum strategies simply rebalance at set intervals, such as quarterly or semi-annually, based on predefined rules for the indices. Active momentum investing, however, takes it a step further. It involves continuous scanning of price and earnings data, dynamically adding or removing stocks based on momentum trajectories. For example, an active manager may exit a stock after a sharp earnings downgrade or enter a stock on signs of strong earnings upgrades, days or weeks ahead of a passive rebalance. This agility can lead to better risk management and the opportunity to capture sharper, shorter-lived trends.
Momentum strategies can suffer during sudden market reversals, like when sentiment shifts abruptly due to geopolitical shocks, regulatory changes, or central bank policy U-turns. Such reversals can inflict sharp drawdowns as yesterday’s winners become today’s laggards. This is why it’s crucial for investors to have the stomach for volatility if they plan to use momentum strategies.
This type of investing rewards decisiveness, punishes hesitation, and thrives on trends. It isn’t a magic bullet, but when combined with discipline, sound risk controls, and a realistic view of your own tolerance for market swings, it can be a valuable tool in your investing arsenal. After all, in markets, sometimes the early bird gets the worm—but the second mouse gets the cheese.
If you cannot spend time in executing an active momentum strategy or lack the expertise, consider a mutual fund with a similar mandate. A prime example is the ICICI Prudential Active Momentum Fund. It is an open-ended scheme which selects stocks based on earnings or price momentum. The New Fund Offer (NFO) period runs from July 08, 2025, to July 22, 2025.
