Winners Keep Winning — For a While
In 1993, Narasimhan Jegadeesh and Sheridan Titman published "Returns to Buying Winners and Selling Losers" in the Journal of Finance, documenting one of the most robust anomalies in financial economics: stocks that have outperformed over the past three to twelve months tend to keep outperforming over the following three to twelve months. Stocks that have underperformed tend to keep underperforming.
This pattern — now called the momentum factor — is one of the most thoroughly replicated findings in asset pricing research. It has been documented across different countries, time periods, and asset classes including equities, bonds, commodities, and currencies.
Why Momentum Persists
Momentum contradicts weak-form market efficiency: if past prices contain no useful information, there should be no return to buying recent winners. The fact that there is requires explanation.
Several behavioural mechanisms have been proposed. Underreaction to news is one leading explanation: when a company reports positive earnings, investors are initially sceptical and do not fully incorporate the good news. The stock drifts upward over subsequent months as more investors recognise the signal. Herding and trend-following also play a role: as momentum becomes obvious, more investors pile in, reinforcing the trend. Overconfidence in extrapolating recent performance can extend the trend beyond fundamentals.
There is no widely accepted risk-based explanation for momentum. Unlike the value and size premiums, where the risk story is at least plausible, momentum is harder to explain through compensation for bearing systematic risk. This is part of why many researchers consider it genuine evidence of market inefficiency.
The Momentum Crash Problem
Momentum strategies carry a distinctive and dangerous risk: severe, rapid drawdowns during market reversals. The most famous example is the "momentum crash" of 2009. As the global financial crisis ended and markets recovered sharply from March 2009 onwards, the worst-performing stocks of the prior twelve months — banks, financial companies — surged the most. Momentum strategies, which were short these losers and long recent winners, suffered catastrophic losses in a very short period.
AQR Capital Management, the firm co-founded by academic Cliff Asness, runs some of the largest momentum-based strategies in the industry. Their research has documented momentum not just in equities but across many asset classes (Asness, Moskowitz & Pedersen, 2013), suggesting a pervasive behavioural phenomenon rather than a quirk specific to one market.
Combining Momentum with Value
An important practical insight: momentum and value tend to have a negative correlation with each other. Value strategies buy recent underperformers (cheap, beaten-down stocks); momentum strategies buy recent outperformers. Because they tend to perform poorly at different times, combining them in a portfolio can reduce overall volatility while preserving the return premium from each. This diversification benefit is one reason multi-factor strategies have become popular among quantitative investors.