Momentum investing: why buying high and selling higher works
Buy low, sell high sounds sensible and is almost impossible to do. Momentum investing takes the opposite approach, and decades of research explain why it can work.
In short
Momentum investing buys assets that have been rising and avoids or sells assets that have been falling. Studies covering stocks, bonds, currencies and commodities, some reaching back more than a century, find that recent strength tends to persist for months. Momentum is not free: it suffers in sideways markets and in sudden reversals, so rules for when to step aside matter as much as rules for when to buy.
What momentum means
Momentum is the tendency of assets that have performed well over the past several months to keep performing well for a while, and of weak assets to stay weak. Investors use it in two ways.
- Relative momentum compares assets with each other. You rank stocks by their past returns and hold the winners. Researchers call this cross-sectional momentum.
- Absolute momentum compares an asset with its own past. If a market is in an uptrend, you hold it; if it is in a downtrend, you step aside. Researchers call this time-series momentum, and practitioners call it trend following.
Levment uses absolute momentum. The question our system asks is not which stock will win, but whether the broad market is in a trend strong enough to justify holding leverage.
The evidence
Momentum is one of the most studied patterns in finance.
In 1993, Narasimhan Jegadeesh and Sheridan Titman showed that U.S. stocks that had performed best over the previous three to twelve months kept outperforming the worst performers over the following months, by roughly one percent a month in their 1965 to 1989 sample.
In 2012, Tobias Moskowitz, Yao Hua Ooi and Lasse Heje Pedersen documented time-series momentum across 58 liquid futures and forward contracts in equity indexes, bonds, currencies and commodities. A market’s return over the past year helped predict its return over the next month, and the strategy did especially well in extreme markets, including severe bear markets.
Later work extended the record. Clifford Asness, Moskowitz and Pedersen found momentum returns across eight different markets and asset classes in 2013, and Brian Hurst, Ooi and Pedersen tested trend following back to the 1880s and found positive average returns in every decade they studied.
Why trends persist
There is no single accepted explanation, but several mechanisms are well documented.
- Underreaction. Investors adjust slowly to new information, so prices move toward fair value over weeks and months rather than all at once.
- Herding and feedback. Rising prices attract attention and new buyers, which can extend a move beyond what the news alone would justify.
- Selling winners too early. Many investors take profits on gains quickly and hold losers too long. That habit, called the disposition effect, slows the price response to good and bad news alike.
- Slow-moving capital. Pension funds, insurers and other large investors rebalance gradually, which spreads their buying and selling over time.
Where momentum fails
Momentum has real weaknesses, and any honest description of it has to include them.
- Sideways markets. When a market moves back and forth without a trend, signals flip repeatedly and each round trip costs a little. Levment’s own deepest drawdown came this way, in 2011 and 2012.
- Sharp reversals. Kent Daniel and Tobias Moskowitz describe “momentum crashes”: sudden rebounds, such as the spring of 2009, when beaten-down assets surged and recent winners lagged badly.
- Lag. A trend has to exist before a rule can confirm it. Momentum investors give up the first part of every move and the last part of every decline.
Why “buy high, sell higher” is not reckless
Buying low requires knowing where the bottom is. Selling high requires knowing where the top is. Both depend on forecasts that very few investors make reliably. Over the fifteen years to 2025, S&P Dow Jones Indices found that 92% of large-cap U.S. fund managers trailed the S&P 500.
Momentum asks a narrower question: is the market rising in a way that has tended to continue? It accepts paying a slightly higher price after a trend is confirmed in exchange for not needing to call turning points. That is the meaning of Levment’s slogan.
How Levment applies momentum
We combine absolute momentum with leverage. A moving-average system confirms when a market trend is real, and proprietary signals refine entries and exits. When the trend is confirmed, we hold leveraged ETFs. When it fades, we reduce or exit that exposure. Every decision is made by rule.
Leverage raises the stakes in both directions, which is why the trend filter is the core of the strategy rather than an extra. Our explainer on volatility decay shows why, and the strategy page describes the process.
Sources
- Jegadeesh, N. and Titman, S. (1993). “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance 48(1).
- Moskowitz, T., Ooi, Y. H. and Pedersen, L. H. (2012). “Time Series Momentum.” Journal of Financial Economics 104(2).
- Asness, C., Moskowitz, T. and Pedersen, L. H. (2013). “Value and Momentum Everywhere.” Journal of Finance 68(3).
- Hurst, B., Ooi, Y. H. and Pedersen, L. H. (2017). “A Century of Evidence on Trend-Following Investing.” Journal of Portfolio Management 44(1).
- Daniel, K. and Moskowitz, T. (2016). “Momentum Crashes.” Journal of Financial Economics 122(2).
- S&P Dow Jones Indices. SPIVA U.S. Scorecard.
This article is educational and is not investment, tax or legal advice. Examples are illustrative and are not Levment results.