The term momentum strategy refers to an investment approach that involves purchasing securities experiencing an upward price trend and selling those that are declining. A momentum strategy relies more on investor sentiment than company fundamentals.
Also known as momentum investing, a momentum strategy is an approach to investing that leverages the recent trend of a security when making purchase or sell decisions. Momentum traders purchase securities experiencing a recent increase in value and sell securities experiencing a recent decline in value.
Momentum traders believe recent trends will continue into the future. This philosophy contrasts with those that believe in the random walk theory, which states past movement cannot be used to predict future movement. This strategy is also at odds with the efficient market hypothesis, which states it is not possible to beat the market because the value of a security reflects all known information.
Seasonality is thought to explain the success investors experience when using this strategy. For example, investors may sell stocks performing poorly throughout the year, driving the price of the security even lower. As the price of the security continues to drop, even more investors decide it is time to sell, thereby continuing the trend.