Momentum Investing: Why Past Winners Keep Winning

Few ideas in finance are as stubborn as momentum. The observation is almost embarrassingly simple: assets that have outperformed over the past several months tend to keep outperforming, and past losers tend to keep lagging. It should not work. In an efficient market, a pattern this well known and this easy to describe ought to have been arbitraged into oblivion decades ago. Instead, more than thirty years after Jegadeesh and Titman's 1993 paper formalised it, momentum remains — in the words of the academic literature — perhaps the most pervasive contradiction of the efficient-market hypothesis still standing.

A recent review from the University of St. Gallen surveys three decades of that research. For family offices, advisers and private investors weighing whether momentum belongs in a portfolio, the useful question is not whether the effect is real — the evidence that it is overwhelms — but what it actually is, why it persists, and what it costs to harvest. The answers are more nuanced, and more practical, than the headline.

Momentum is everywhere

The first striking fact is breadth. Momentum is not a quirk of US large-cap stocks. The same buy-winners, sell-losers pattern has been documented in European equities, in markets across Asia, in mutual-fund performance, in commodity futures, in government and corporate bonds, in currencies, and most recently in cryptocurrencies. When a strategy shows up independently in that many unrelated markets, it is unlikely to be a statistical fluke or an artefact of one dataset. Whatever momentum is, it appears to be a deep feature of how prices move.

The standard construction is straightforward. Rank assets by their return over a formation period — typically the past three to twelve months — then hold the winners and short the losers over the following months. One detail matters: practitioners almost always skip the most recent month, because over very short horizons prices tend to reverse rather than continue. Momentum lives in the intermediate horizon, not the immediate one.

The catch: momentum crashes

If momentum simply paid out steadily, it would be the easiest money in markets. It does not. The defining risk of momentum is the momentum crash: rare but brutal drawdowns that strike at the worst possible moment.

Crashes happen when a falling market reverses sharply. After a bear market, the "loser" stocks a momentum strategy is short have become beaten-down, high-volatility names. When sentiment turns and the market rebounds, those losers rocket upward — and the strategy, positioned against exactly those stocks, takes the full force of the rebound. Researchers describe the payoff profile as resembling a short call option: it grinds out small gains for long stretches, then occasionally suffers a violent loss. The rebound of 2009 is the textbook example.

This is the single most important thing for an allocator to understand. Momentum's long-run record is excellent, but its return comes with a specific, identifiable tail risk concentrated at market turning points.

Risk management changes everything

The encouraging news — and the most actionable finding in the literature — is that this tail risk can be largely managed. Because momentum crashes coincide with spikes in volatility, scaling the strategy's exposure to its own recent volatility tames the worst of them: when volatility rises, you cut exposure; when it falls, you add. It is the same volatility-scaling logic that underpins target-risk multi-asset strategies more broadly.

The numbers are notable. One widely cited study found that scaling momentum by its inverse volatility roughly doubled its risk-adjusted return, lifting the Sharpe ratio from about 0.68 to 1.20. A related refinement — residual momentum, which strips out a stock's broad factor exposures before ranking — cut volatility nearly in half and lifted the Sharpe ratio from roughly 0.45 to 0.90. The raw signal is good; disciplined risk management is what makes it institutional-grade.

Why does momentum exist?

Here the literature splits, and the debate is genuinely unresolved. Two camps offer competing explanations.

The behavioural camp argues momentum reflects predictable human error. Investors underreact to news, so prices drift toward fair value gradually rather than instantly. Or they overreact, with trend-chasers pushing winners past fair value before an eventual reversal. Related biases reinforce the pattern: a reluctance to sell stocks near a 52-week high, overconfidence after a run of good calls, and the disposition effect — selling winners too early and clinging to losers too long. Tellingly, momentum is stronger among smaller, less-covered stocks where information spreads slowly, and far stronger in optimistic, high-sentiment markets than in cautious ones.

The risk-based camp insists momentum is simply compensation for bearing risk that standard models miss — exposure to growth-option risk, liquidity risk, or the heightened risk of the lower-credit-quality firms that drive much of the effect. On this view there is no free lunch; the returns are a fair fee for a real, if subtle, danger.

For a practitioner, the debate matters less than its implication: whether momentum stems from hard-wired behaviour or from priced risk, either way there is reason to expect it to persist rather than vanish the moment it becomes widely known.

The frontier: it may not be about individual stocks at all

The most intriguing recent development reframes the whole question. A growing body of work finds that momentum is not really a stock-level phenomenon but a factor-level one. Investment factors themselves — value, size, profitability and dozens of others — trend: a factor that has done well lately tends to keep doing well. Several studies now argue that this factor momentum largely subsumes both individual-stock momentum and industry momentum. In other words, what looks like winning stocks continuing to win may mostly be winning factors continuing to win, expressed through the stocks that happen to load on them.

This is more than academic housekeeping. If factor momentum is the true engine, the most efficient way to capture the effect may be at the factor level rather than through a conventional single-stock winners-minus-losers book — a meaningful design choice for anyone building a systematic allocation.

What it means for allocators

Three decades of evidence support a few clear conclusions. Momentum is real, unusually robust, and diversifying — it has historically shown low or negative correlation with value, which is why the two are so often paired. But it is not a set-and-forget exposure. Its returns are punctuated by sharp crashes at market turning points, and capturing it well depends far more on disciplined risk management than on the precise ranking rule. The strategies that have endured are the risk-managed ones.

For family offices and private investors, the takeaway is not "buy a momentum fund." It is to understand momentum as a distinct, well-evidenced return source with a specific risk signature — one that rewards rigour in implementation and punishes naivety. Used as a complement to other premia, and run with proper volatility control, it remains one of the most compelling pieces of evidence that markets are not quite as efficient as theory would like.

At Vayo Capital, that combination — durable, evidence-based return sources paired with systematic risk management — is the foundation of how we build multi-strategy portfolios.

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This article draws on "Momentum: what do we know 30 years after Jegadeesh and Titman's seminal paper?" by Tobias Wiest (Financial Markets and Portfolio Management, 2022), a review of more than 60 studies on momentum, the large majority published in the field's leading journals. Figures cited reflect the studies surveyed and are not a representation of Vayo Capital returns. Nothing here is investment advice.

Frequently asked questions

What is momentum investing? Momentum investing is a strategy that favours assets which have performed well over a recent formation period (typically 3 to 12 months) and underweights or shorts recent underperformers, based on the empirical observation that relative performance tends to persist over intermediate horizons.

Does momentum work outside the stock market? Yes. The momentum effect has been documented across asset classes — including equities worldwide, commodity futures, government and corporate bonds, currencies, and cryptocurrencies — which is a major reason researchers consider it so robust.

What is a momentum crash? A momentum crash is a large, rapid loss that momentum strategies can suffer when a falling market reverses sharply. Beaten-down "loser" stocks rebound violently, hurting strategies positioned against them. Crashes are concentrated in volatile market turning points, such as 2009.

Can the risk of momentum be managed? Largely, yes. Because crashes coincide with high volatility, scaling exposure to recent volatility has historically reduced the worst drawdowns and, in several studies, roughly doubled momentum's risk-adjusted return. Residual and risk-managed momentum are common institutional refinements.

Why does momentum exist? There are two main explanations. Behavioural theories attribute it to investor errors such as underreaction to news, overconfidence, and the disposition effect. Risk-based theories argue it compensates investors for bearing risks that standard models miss. The debate is unresolved, but both imply the effect may persist.