What Is Momentum Investing? Relative Strength and Why Stocks Trend

Momentum investing is the observation that stocks which have outperformed over the past several months to a year tend to keep outperforming for a while longer. That is more than random chance would predict. It says nothing about what any single stock does tomorrow. It is a pattern found across decades of market data, and it is the idea behind MoatMint's Momentum rating.

What momentum investing means, in one sentence

Momentum investing is simple to state. Stocks that have already outperformed the market tend to keep outperforming it, at least for a while. Narasimhan Jegadeesh and Sheridan Titman first documented this in 1993, showing that stocks ranked in the top tier by trailing return kept beating the bottom tier over the following months. The effect has since been replicated across decades and international markets, including a 2013 study by Clifford Asness, Tobias Moskowitz and Lasse Pedersen that found the same value and momentum patterns across stocks, bonds, currencies and commodities in markets worldwide. Mark Carhart added momentum to the standard set of return factors in 1997, when he showed that momentum, alongside market, size and value, explained much of what had looked like mutual-fund manager skill. That is why the momentum factor is now treated as a standard driver of returns, alongside quality, value and growth.

Momentum investing does not forecast what a specific stock does next week. It is a statistical pattern found across large groups of stocks. It says nothing about any one company's fundamentals or future results on its own.

Relative strength: how momentum is actually measured

The standard way to measure momentum is relative strength. It ranks a stock's price performance against the broader market or other stocks over a trailing period, typically the past year. A stock with high relative strength has beaten most other stocks over that stretch. A stock with low relative strength has lagged most others.

Relative strength starts with a stock's own trailing return. That return is then converted into a rank or percentile against every other stock at the same time. So instead of just "this stock rose 15%," you get "this stock outperformed most of the market over the past year."

One detail in that measurement is easy to overlook: most relative strength measures set aside the most recent month before scoring.

Why the most recent month gets left out

A stock's very latest month of price action tends to partially reverse itself. A stock that has just jumped often gives some of that jump back the following month. A stock that has just dropped often bounces a little. Counting the most recent month at full weight risks mistaking a short-lived swing for a genuine trend.

The standard construction avoids that trap. It looks at the year before the most recent month, rather than the full trailing year including it. That keeps the measurement anchored to the slower-moving trend. It is less exposed to being fooled by a bounce or a dip that has nothing to do with the stock's real trajectory.

Not every relative-strength measure treats the most recent stretch the same way. William O'Neil, who launched Investor's Business Daily in 1984, built a different approach into his CAN SLIM system: the IBD Relative Strength Rating weights a stock's most recent quarter of price performance at 40% and each of the three prior quarters at 20%, then ranks the weighted total on a scale of 1 to 99 against every other stock. That practitioner construction overweights the most recent quarter instead of excluding it. Academic momentum research skips the most recent month to avoid short-term reversal. IBD's rating instead emphasizes it. Both are real, established ways of measuring the same underlying idea.

Relative strength vs the RSI indicator, a common mix-up

Relative strength, as used in momentum investing, is a medium-term measure of how a stock's price has performed against the market over months, and it is the idea behind MoatMint's Momentum rating. It is often confused with the Relative Strength Index (RSI), a short-term technical indicator built from recent daily price swings that shares the name but measures something different. Our guide to the RS Rating has the full side-by-side comparison.

Volume and turnover, a secondary check, not the main signal

A price trend backed by heavier-than-usual trading activity is generally more credible than the same move on thin volume. If a stock rises on unusually high turnover, more investors are voting with real money. Some research treats that as a modest confirming signal on top of the price trend itself.

The price trend is the primary signal. A turnover check adds a smaller, supporting layer of evidence.

Momentum investing vs momentum, or day, trading

Momentum investing, as researched in academic finance, works over months. It has little to do with short-term or intraday momentum trading. Day traders try to catch price swings over minutes, hours or days, using charts and technical signals.

MoatMint's Momentum rating reflects the medium-term research factor. It is never a day-trading or technical-chart signal. MoatMint does not offer intraday alerts or trading signals of any kind. If the word "momentum" makes you picture a trading desk watching a ticker tape, that is a different discipline from momentum investing.

The business side of momentum, is the company itself speeding up?

Price momentum is one side of the idea. Academic research also pairs it with a second question: is the underlying business accelerating, with earnings and sales growth picking up? Louis Chan, Narasimhan Jegadeesh and Josef Lakonishok studied this pairing in 1996, finding that past returns and past earnings surprises each predicted future stock performance on their own, even after accounting for the other, with little evidence that stocks strong on both later reversed. That pairing of price and business momentum is cited here as intellectual lineage, not an endorsement of any specific method.

MoatMint scores this second question separately, in its Growth rating. That way, an investor can see price trend and business trend as two separate, comparable pieces of evidence, rather than one blended number. Momentum is one of five factors behind the overall MoatMint rating, alongside Quality, Growth, Value and Financial Health. See our guide to MoatMint's five-factor rating for how all five fit together.

Business acceleration is a different question from business durability. A company can show accelerating sales for a few quarters without having the kind of lasting edge that protects those results for years. Our guide to wide-moat companies covers that kind of durable advantage.

The real risk: momentum can reverse sharply

Momentum has a well-documented failure mode. After market shocks or bear-market bottoms, past winners and losers can swap places abruptly and painfully. Stocks that fell hardest often bounce first, while the recent leaders lag. An investor following momentum through one of these reversals can watch a strategy that looked strong for years lose money quickly.

Academic evidence also suggests momentum returns have moderated somewhat since the effect was first published in the 1990s. David McLean and Jeffrey Pontiff examined 97 return-predicting patterns, including momentum, in 2016 and found returns were substantially lower after publication than in the original research, consistent with a mix of data-mining bias and investors trading away an edge once it becomes public knowledge. That is a normal pattern for a well-documented market signal. Once more investors know about an edge and trade around it, the edge tends to shrink, even if it does not disappear. Momentum remains a real, historically supported pattern. But it is not risk-free, and not one to rely on alone.

How MoatMint's Momentum rating applies this

MoatMint's Momentum rating is scored 0 to 10 and refreshed daily, like every rating. It scores a stock mainly on relative strength versus the market, with a supporting turnover check. It is one of five rating factors, alongside Quality, Growth, Value and Financial Health, never a standalone timing signal.

MoatMint's momentum stock screener also shows a standalone Relative Strength metric. That is the same underlying price-trend measurement on its own, without the turnover check folded in. So you can look at price trend by itself, or at the fuller Momentum rating that adds the turnover check on top.

Using a momentum score as a research signal, not a trade trigger

A high Momentum rating flags a stock the market is already rewarding. That is a useful input. It is best paired with checking the business's quality and moat, and whether the price is still reasonable, not acted on by itself. A stock can carry strong momentum and weak underlying quality at the same time. That reversal risk is exactly why momentum alone is not enough.

Start with MoatMint's momentum stock screener to find stocks the market is currently rewarding. Then check the business itself. Our guide to economic moats explains how to judge whether a company's edge is durable. Our guide to returns on capital explains how to see whether the business turns capital into profit efficiently. A rising stock backed by a wide moat and strong returns on capital is a very different proposition from a rising stock with neither.

MoatMint ratings and this article are for informational and educational purposes only, not personalized investment advice.