Price Momentum Strategy
Buy recent winners, sell recent losers. A strategy backed by 30+ years of academic research across global markets.
Overview
The momentum effect has been validated across decades of research and multiple asset classes. Stock returns show a certain "inertia": future returns are positively correlated with past returns.
In plain terms: stocks that have performed well recently tend to continue performing well, and stocks that have performed poorly tend to continue underperforming.
The strategy ranks all stocks by past performance over a "formation period," then buys the top performers (winners) and optionally shorts the bottom performers (losers).
Key Insight
Momentum in Action: Winners vs Losers
This chart shows two hypothetical stocks over 13 months. The momentum strategy would buy Stock A (the winner) and short Stock B (the loser), betting that recent trends continue.Hover over the chart to see values.
Research
Eight landmark papers spanning three decades of momentum research.
The Mathematics
In Plain English
The math behind this strategy is straightforward. Here's what you're actually doing:
- 1Look back 12 months (but skip last month). If a stock was $100 a year ago and is $130 now, that's a 30% gain.
- 2Rank every stock by this percentage gain. The stocks with the biggest gains go to the top of your list.
- 3Buy the top performers (typically the top 10% or 20%). These are your "winners."
- 4Optionally short the bottom performers (the worst 10%). These are your "losers."
That's it. The formulas below just express this process precisely.
1Monthly Return
The simple return for stock i in month t.
2Cumulative Return (Formation Period)
Total return over the T-month formation period, skipping the most recent S months. Typically T = 12 months and S = 1 month.
3Mean Monthly Return
Average monthly return over the formation period.
4Risk-Adjusted Return (Optional)
Mean return divided by volatility. Essentially a Sharpe-ratio based ranking.
Why Skip the Most Recent Month?Note
Research shows a short-term mean-reversion effect in the most recent month, possibly due to liquidity/microstructure issues. Skipping the most recent month (S=1) improves strategy performance by avoiding this "contrarian" effect.
Strategy Rules
Calculate Performance Scores
At the end of each month, calculate the cumulative return R^cum for every stock in your universe over the past 12 months, skipping the most recent month.
Rank All Stocks
Sort all stocks by their performance score in descending order (best performers at the top).
Select Winners (and Losers)
Long-Only: Buy stocks in the top decile (top 10%) or top quintile (top 20%). Long-Short: Additionally short stocks in the bottom decile (bottom 10%).
Weight the Portfolio
Equal Weight: Allocate the same dollar amount to each position. Volatility-Adjusted: Weight inversely proportional to volatility (w proportional to 1/sigma).
Hold and Rebalance
Hold positions for the holding period (typically 1-12 months). At the end of the holding period, repeat the process. Momentum effects diminish with longer holding periods.
Implementation Guide
Implementing a momentum strategy doesn't require advanced programming skills. Here's a practical guide to get started using common tools and your brokerage platform.
Choose Your Stock Universe
Start with a well-defined group of stocks to screen. The S&P 500 is ideal for beginners—it contains 500 large, liquid companies that are easy to trade. You can also use sector-specific ETF holdings or an index like the Russell 1000 for more options.
- Avoid penny stocks (under $5) as they have unreliable momentum signals
- Stick to stocks with average daily volume above 100,000 shares
- You can find S&P 500 constituents on Wikipedia or financial sites like Slickcharts
Set Up a Stock Screener
Use a free stock screener to find top momentum stocks. Most screeners let you sort by "52-week performance" or "6-month return"—these are close approximations to the academic 12-month momentum signal. Finviz, TradingView, and Yahoo Finance all offer free screening tools.
- Filter for Performance > 20% over 6 months or 1 year as a starting point
- Look at the "Performance" tab in Finviz for easy sorting
- Some brokers like Fidelity and Schwab have built-in screeners
Rank and Select Winners
Sort your screened results by past performance (highest to lowest). Select the top 10-20 stocks for a concentrated portfolio, or the top 10% for a more diversified approach. These are your "winners" to buy.
- Write down your selection criteria and stick to it each month
- Consider excluding any stock that had major news (merger, scandal) causing the return
- The "skip month" rule: ignore the most recent month's return when ranking
Don't chase the single highest performer. Spread across at least 10 stocks to reduce single-stock risk.
Decide on Position Sizing
The simplest approach is equal-weighting: divide your capital equally among all selected stocks. For a $10,000 portfolio with 10 stocks, that's $1,000 per position. This keeps things simple and ensures no single stock dominates your returns.
- Equal-weight is the standard academic approach and works well in practice
- Some investors prefer limiting each position to 5% of the portfolio
- Make sure each position is large enough to be worth the trading commission
Execute Your Trades
Place your buy orders through your brokerage. Use limit orders to control your entry price, especially for less liquid stocks. Most momentum traders execute at month-end or on the first trading day of each month for consistency.
- Market orders are fine for highly liquid S&P 500 stocks
- Consider using limit orders set slightly below market price
- Trade during regular market hours (9:30 AM - 4 PM ET) for best execution
Rebalance Monthly
At the end of each month, re-run your screen and compare the new top stocks to your current holdings. Sell positions that have dropped out of the top ranks and buy new winners that have entered. This is the key discipline of momentum investing.
- Set a calendar reminder for the last trading day of each month
- Track your trades in a spreadsheet to monitor turnover and costs
- Some positions may stay in the portfolio for multiple months—that's normal
Momentum requires discipline. Avoid the temptation to hold losers hoping they'll recover—the strategy works by cutting losers and riding winners.
Choosing a Broker
Most major brokers now offer commission-free stock trading, making momentum strategies more viable for smaller accounts. Interactive Brokers, Fidelity, Schwab, and TD Ameritrade all work well. Look for a broker with good screening tools and low margin rates if you plan to use leverage.
Helpful Tools & Resources
Strategy Variations
Explore different ways to implement this strategy, each with its own trade-offs and benefits.
Long-Only
Only buy winners (top decile). Simpler to implement, no short-selling required. Lower returns but also lower risk and transaction costs.
Long-Short (Dollar Neutral)
Buy winners, short losers with equal dollar exposure. Zero net market exposure, providing pure momentum alpha.
Risk-Adjusted Momentum
Rank by return/volatility instead of raw return. Favors stocks with smoother uptrends over volatile gainers.
Overlapping Portfolios
Build 12 overlapping 1-month portfolios (one formed each month). Smooths turnover and reduces timing sensitivity.
Risks & Limitations
Momentum can suffer severe drawdowns during market reversals (e.g., 2009 recovery). Winners suddenly become losers and vice versa.
Momentum is a well-known strategy. Crowded trades can reduce returns and increase crash risk.
Monthly rebalancing leads to significant trading costs. Consider transaction costs when evaluating expected returns.
Frequent trading generates short-term capital gains. Consider using tax-advantaged accounts.
Very large portfolios may face liquidity issues, especially in smaller stocks.
References
- Jegadeesh, N., & Titman, S. (1993). Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency. Journal of Finance, 48(1), 65-91 [Link] [PDF]
- Carhart, M. M. (1997). On Persistence in Mutual Fund Performance. Journal of Finance, 52(1), 57-82 [Link] [PDF]
- Asness, C. S., Moskowitz, T. J., & Pedersen, L. H. (2013). Value and Momentum Everywhere. Journal of Finance, 68(3), 929-985 [Link] [PDF]
- Asness, C. S., Frazzini, A., Israel, R., & Moskowitz, T. J. (2014). Fact, Fiction and Momentum Investing. Journal of Portfolio Management, 40(5), 75-92 [Link]
- Daniel, K., & Moskowitz, T. J. (2016). Momentum Crashes. Journal of Financial Economics, 122(2), 221-247 [Link] [PDF]
- Blitz, D., Hanauer, M., & Vidojevic, M. (2020). The Idiosyncratic Momentum Anomaly. International Review of Economics & Finance, 69, 932-957 [Link] [PDF]
- Ehsani, S., & Linnainmaa, J. T. (2022). Factor Momentum and the Momentum Factor. Journal of Finance, 77(3), 1877-1919 [Link] [PDF]
- Hanauer, M. X., & Windmuller, S. (2023). Enhanced Momentum Strategies. Journal of Banking & Finance, 148, 106731 [Link] [PDF]
- Cakici, N., Fieberg, C., Metko, D., & Zaremba, A. (2024). Factor Momentum versus Price Momentum: Insights from International Markets. Journal of Banking & Finance, 169, 107318 [Link] [PDF]
Ready to Explore More Strategies?
Access our complete library of 100+ academic-backed trading strategies across stocks, options, futures, currencies, and more.
Browse All Stock Strategies