Momentum investing is an investment strategy that focuses on following current market trends and generating returns based on those trends. The basic theory behind this investing activity is that by taking note of the upward and downward movement of a given security, it is possible to identify the trend and use it to best advantage. When the trend indicates a continued upward movement, the investor can buy shares and hold them throughout the trend, earning a return. Should the trend indicate a steady downward movement, the investor sells before the price falls below what he or she paid for the shares, and avoids incurring a loss.
When utilizing a momentum investing model, many proponents recommend looking closely at the movement of a security for no less than three months, and as much as twelve consecutive months. Doing so is thought to provide ample information to determine the course of the trend, and execute trading orders accordingly. The expectation is that once a trend is identified, it can reasonably be expected to continue for an appreciable period of time, allowing the investor to earn the most benefit from the projection.
The returns generated by using momentum investing are not generally seen as being spectacular. Rather, the income generated from this type of strategy is usually modest but consistent. When used as a means of selecting investments that are stable and continue to perform well throughout the year, this approach to investing can be very attractive for investors who do not like to take on substantial risks. While the return may be modest, proponents note that it is consistent from one month to the next as long as the trend persists, and allows the investor to incrementally increase the value of his or her portfolio without dealing with much in the way of volatility.
While some investors find the process of momentum investing very useful, others do not agree with the basic idea behind the strategy. While most would agree that projecting upcoming trends is a part of choosing investments wisely, relying mainly on past performance is not enough. Critics of the approach note that momentum investing generally does not provide an equitable amount of consideration for general market conditions, including the possibility of the effect of upcoming events on current trends. For example, momentum investing does not usually consider how the outcome of a political election may affect one or more sectors of the marketplace, including the sector where the security under consideration is traded.