Market rally fuels interest in momentum investing strategies

Equities have enjoyed a solid run so far in 2025, including new record highs for the FTSE 100 and the S&P 500 indices. There is optimism across the markets and that typically encourages certain investors to look at a particular strategy, namely momentum investing.

There is a much-used phrase in investing that says ‘a rising tide lifts all boats’, meaning that economic growth will benefit everyone. Investors often adopt that phrase in the belief that stocks of any quality might increase in value if markets are racing ahead.

That approach can backfire if you’re not careful, as the tide can turn quickly. Instead, it might pay to consider more specific momentum investing techniques that aim to filter out parts of the market, and where certain signals identify when to consider buying or selling. Fund managers often deploy such techniques, as do computer-based investment strategies including certain factor-based ETFs.

What is momentum investing?

Strength in share price performance or earnings relative to the broader market over the past 12 months are often at the heart of momentum investing. Investors look for companies ‘on a roll’ and hope this success will continue. It’s a bit like a surfer riding a wave, hoping they get a good, long ride.

“The success of momentum is probably best explained by behavioural finance theories – that is, investors will tend to buy stocks whose price is going up, leading to further upward pressure on the stock’s price,” says asset manager BlackRock.

The idea of buying a stock when its share price is flat or falling is alien to certain individuals, particularly those who are less experienced investors. They might only want to buy what’s going up, believing that is a symbol of a worthwhile investment. In reality, buying when others have lost interest can yield big rewards down the line, but certain people simply want to ride an upwards wave even if it means paying a higher price for a stock. It’s pure FOMO – fear of missing out.

Putting momentum strategies into practice

Momentum investing can involve a large element of timing the market. To add a degree of control, investors might look to only buy and sell shares when they perform in a certain way.

For example, one strategy is to buy a stock when it hits a 12-month high and then keep buying if it continues to hit new highs. A potential trigger to consider exiting a trade is when the stock hits a three-month low.

Fund managers often use this approach as a starting point and then refine the momentum strategy by adding additional criteria.

There are various momentum indices which form the backbone for factor ETFs. For instance, the MSCI All Countries World is a popular benchmark for global equities. There is a momentum version of this index that focuses on stocks with high price momentum, rebalanced twice a year.

Long-term past performance data is interesting, as it shows the momentum strategy has the potential to beat the market. In the 20 years to 20 August 2025, the MSCI ACWI Momentum index returned 588% versus 404% from the ‘normal’ MSCI ACWI index. This outperformance was also recorded over the past one, three and ten years (but not five years). While these statistics are enlightening, it’s important to remember that what’s worked in the past won’t necessarily work in the future.

Spotting a shift in the market

As any surfer will tell you, riding a wave can be spectacular but it’s hard to sustain. Momentum investing comes with similar thrills and disappointments. It can lead to heightened volatility in an investment portfolio and requires an ability to read the mood of the market.

As such, it’s worth following market sentiment indicators, as these can act like a traffic light system. Bullish sentiment often implies that conditions are positive for momentum trades, whereas a sudden switch to bearish sentiment can signal a potential loss of momentum.

CNN publishes a ‘Fear and Greed’ index on its website that features different indicators including ‘market momentum’ based on the US stock market. It says a ‘greed’ status can drive up share prices and ‘fear’ the opposite.

When the S&P 500 is above its moving or rolling average of the prior 125 trading days, CNN says that’s a sign of positive momentum. But if the index is below this average, it suggests investors are getting skittish.

At the time of writing (21 August), CNN’s fear and greed index sat at the higher end of ‘neutral’ and just below ‘greed’, with the market momentum factor registering ‘neutral’.

Momentum investing might form part of an investors’ portfolio, particularly on the sidelines as a way to take higher risks. However, it is less common for it to be at the core of someone’s investment strategy, as that’s more likely to feature ‘get rich slowly’-type assets.

Past performance is not a guide to future performance and some investments need to be held for the long term.