2.6.3 Momentum Factor

Why trends have historically tended to persist

Momentum as a factor is built on the observed tendency for stocks that have risen strongly over the past six to twelve months to continue outperforming, on average, over the following few months, and for stocks that have fallen sharply to continue underperforming. This pattern has shown up across many markets and long historical periods, even though the underlying behavioural or structural reasons behind it remain debated among researchers.

Why momentum can reverse sharply

Momentum strategies are particularly prone to sudden, sharp reversals, sometimes called momentum crashes, especially around major market turning points when previously strong trends abruptly break down. This is one of the more distinct risks of a momentum-based approach compared to some other factors.

How momentum is typically used

Momentum is often combined with other factors, such as quality, in an attempt to filter out some of the weaker, more crash-prone momentum signals while retaining the core trend-following benefit. As with any single factor, a dedicated momentum allocation is generally best sized as a smaller, deliberate portion of a broader, diversified portfolio rather than a dominant strategy on its own.