Systematic investing using quantitative factors has become established in modern portfolio theory. One of the best documented and most widely used factors is the momentum factor. It describes the tendency of investment instruments such as shares to continue price trends: Shares with strong relative performance over a defined period of time are more likely to achieve above-average returns in the near future – and vice versa. This scientific foundation is an important pillar of the Everon multi-factor strategy.
What is momentum?
Momentum measures the relative price change of a share over a certain period of time. A common calculation formula is
wherePi,t is the price of share i at time t and k is the period under consideration in months (typically 6 to 12 months).
Alternatively, momentum can be formulated as a risk-adjusted return, e.g. using the Sharpe ratio (ratio of return to risk) on a rolling basis. Momentum is one of the factors with a robust historical excess return:
- In the USA, the momentum factor generated an annualized excess return of around 5-7% p.a. between 2000 and 2020 (depending on the methodology).
- Similar premiums can also be seen in Europe and the emerging markets, albeit with higher volatility.
- Compared to other factors – such as value or size – momentum was particularly successful in the late 2010s, especially in phases of low interest rates and clear market trends.
Reading tip: Factor Risk Premia: Value, Momentum, Size, and Quality in Recent Years
Momentum typically works in market phases with:
- clear trend (e.g. expansionary monetary policy phases),
- fundamental divergence (e.g. sector rotation),
- high investor focus on relative strength (e.g. growth phases).
Momentum, on the other hand, shows weaknesses in:
- Trend breaks (e.g. after market corrections or political shocks),
- strong reversal behavior (e.g. in the Covid recovery phase March-June 2020),
- narrowed markets when only a few stocks drive index performance (momentum cluster risk).
Momentum typically has the following characteristics
- Negative correlation to the value factor (especially for highly undervalued stocks that are considered turnaround candidates),
- Slightly positive correlation to the quality factor (highly profitable growing companies often also perform well in terms of momentum),
- Low correlation to the low-volatility factor
These characteristics make momentum an effective diversifier in a multi-factor portfolio approach.
Different momentum definitions
There are numerous variants of the momentum concept:
- Price-based indicators:
- 12M-1M performance (classic)
- 6M performance, 3M performance, 1M reversal
- Average performance rank over several time windows
- Technical indicators:
- Relative Strength Index (RSI)
- Moving Average Convergence Divergence (MACD)
- Distance to the 200-day line
- Risk-adjusted variants:
- Return/volatility over 6-12 months
- Momentum score relative to sector or market volatility
The choice of definition depends on the objective of the investment: aggressive timing, defensive rebalancing or neutral stock ranking.
Our approach at Everon
At Everon, we do not integrate momentum as a monolithic metric, but as a component-based score that combines several sub-indicators. For example, our portfolio management engine uses
- short, medium and long-term price momentum.
- Sector-adjusted momentum rankings,
- risk-adjusted momentum values based on rolling Sharpe ratios,
- technical trend filters.
These sub-scores are combined into a weighted total value, which flows into our dynamic weighting of a stock’s final score. Momentum does not work in isolation, but in combination with other factors such as value, quality or volatility. Depending on the market phase, the momentum scores can be weighted more or less heavily.
Example: In a stable bull market with clear sector rotation, momentum can be an important criterion for overweighting. In volatile sideways markets, on the other hand, we specifically reduce the relevance of momentum-driven components in order to limit reversal risks.
Reading tip: Factor Investing with Everon
Conclusion
Momentum is a versatile and proven factor in systematic investing – but it is not a sure-fire success. A robust, multidimensional definition is crucial.
