Momentum investing is a strategy to make money based on the current trend of a stock of a company. By current trend, we refer to the trend for the past 6 months to 1 year. Therefore, if a stock is going up, it is assumed that the prices will keep rising. The logic is so simple People want to buy rising stocks. Think of it in terms of Newton’s law of motion which states that if all external forces cancel each other out, then the object will keep moving in the same velocity and if the velocity is 0 (zero), the object will remain at rest. The ‘object’ here is the stock of a company.
Momentum investing is seen as a “premier market anamoly.” An anomoly occurs when a theory against the assumption of a rational market. Momentum goes against the theories of a rational market because of the hot hand fallacy. Hot hand fallacy means that of some has a string of successes in an event, they are likely to succeed in that event the next time. However, that may not always be true. So in our situation, if a stock has been going up that does not mean that it will keep going up in future.
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