What Is Momentum Trading?
Momentum trading is the opposite of mean reversion: buy what's going up, sell what's going down. The thesis is that recent winners outperform recent losers over horizons of 1-12 months — a phenomenon repeatedly documented in academic finance.
Common implementations: rank a universe by 6-month return and buy the top decile (12-month momentum); buy stocks above their 200-day moving average; or scan for breakouts above multi-month highs. The strategy requires discipline — momentum reverses sharply at inflection points.
Momentum works because investors are slow to update beliefs and herding pushes trends further than fundamentals justify. The catch is that when momentum breaks, the unwind is fast and brutal. Drawdowns of 30-50% are typical during regime shifts. Most academic momentum strategies still don't trade below the 1-month window.
Related terms
- Trend — The general direction of price movement over a period — uptrend, downtrend, or sideways.
- Breakout — A price move beyond an established support, resistance, or chart pattern boundary.
- RSI (Relative Strength Index) — A momentum oscillator (0-100) measuring the speed and magnitude of recent price changes.
- Mean Reversion — Strategy betting that price will return toward its average after extreme moves.