Momentum Strategy
A momentum strategy seeks to buy assets that have performed well recently and sell or avoid assets that have performed poorly. It relies on the tendency for trends to persist over a defined horizon.
Types of momentum
- Time series momentum: trade the same asset based on its own past returns.
- Cross sectional momentum: rank assets and go long the winners and short the losers.
Example
A monthly momentum model ranks a universe of stocks by 12 month return and holds the top decile while avoiding the bottom decile.
Risks
Momentum can experience sharp crashes during sudden reversals. It is sensitive to liquidity, transaction costs, and regime shifts.
Practical notes
Many momentum strategies use risk controls such as volatility scaling, trend filters, or crash protection to manage drawdowns.
Practical checklist
- Define the time horizon for Momentum Strategy and the market context.
- Identify the data inputs you trust, such as price, volume, or schedule dates.
- Write a clear entry and exit rule before committing capital.
- Size the position so a single error does not damage the account.
- Document the result to improve repeatability.
Common pitfalls
- Treating Momentum Strategy as a standalone signal instead of context.
- Ignoring liquidity, spreads, and execution friction.
- Using a rule on a different timeframe than it was designed for.
- Overfitting a small sample of past examples.
- Assuming the same behavior in abnormal volatility.
Data and measurement
Good analysis starts with consistent data. For Momentum Strategy, confirm the data source, the time zone, and the sampling frequency. If the concept depends on settlement or schedule dates, align the calendar with the exchange rules. If it depends on price action, consider using adjusted data to handle corporate actions.
Risk management notes
Risk control is essential when applying Momentum Strategy. Define the maximum loss per trade, the total exposure across related positions, and the conditions that invalidate the idea. A plan for fast exits is useful when markets move sharply.
Variations and related terms
Many traders use Momentum Strategy alongside broader concepts such as trend analysis, volatility regimes, and liquidity conditions. Similar tools may exist with different names or slightly different definitions, so clear documentation prevents confusion.
Practical checklist
- Define the time horizon for Momentum Strategy and the market context.
- Identify the data inputs you trust, such as price, volume, or schedule dates.
- Write a clear entry and exit rule before committing capital.
- Size the position so a single error does not damage the account.
- Document the result to improve repeatability.
Common pitfalls
- Treating Momentum Strategy as a standalone signal instead of context.
- Ignoring liquidity, spreads, and execution friction.
- Using a rule on a different timeframe than it was designed for.
- Overfitting a small sample of past examples.
- Assuming the same behavior in abnormal volatility.
Data and measurement
Good analysis starts with consistent data. For Momentum Strategy, confirm the data source, the time zone, and the sampling frequency. If the concept depends on settlement or schedule dates, align the calendar with the exchange rules. If it depends on price action, consider using adjusted data to handle corporate actions.
Risk management notes
Risk control is essential when applying Momentum Strategy. Define the maximum loss per trade, the total exposure across related positions, and the conditions that invalidate the idea. A plan for fast exits is useful when markets move sharply.
Variations and related terms
Many traders use Momentum Strategy alongside broader concepts such as trend analysis, volatility regimes, and liquidity conditions. Similar tools may exist with different names or slightly different definitions, so clear documentation prevents confusion.
Practical checklist
- Define the time horizon for Momentum Strategy and the market context.
- Identify the data inputs you trust, such as price, volume, or schedule dates.
- Write a clear entry and exit rule before committing capital.
- Size the position so a single error does not damage the account.
- Document the result to improve repeatability.
Common pitfalls
- Treating Momentum Strategy as a standalone signal instead of context.
- Ignoring liquidity, spreads, and execution friction.
- Using a rule on a different timeframe than it was designed for.
- Overfitting a small sample of past examples.
- Assuming the same behavior in abnormal volatility.
Data and measurement
Good analysis starts with consistent data. For Momentum Strategy, confirm the data source, the time zone, and the sampling frequency. If the concept depends on settlement or schedule dates, align the calendar with the exchange rules. If it depends on price action, consider using adjusted data to handle corporate actions.
Risk management notes
Risk control is essential when applying Momentum Strategy. Define the maximum loss per trade, the total exposure across related positions, and the conditions that invalidate the idea. A plan for fast exits is useful when markets move sharply.