Momentum investing: what it is and 10 momentum ETFs to watch

What is momentum investing?

Momentum investing is a strategy used in financial markets where investors focus on buying assets that have shown strong performance in the past and selling assets that have demonstrated weak performance.

The underlying theory behind the momentum investing strategy is that assets that have performed well in the recent past could continue their positive performance, while those that have performed poorly could continue to underperform.

Key characteristics of momentum investing

• Focus on price trends: Momentum investors primarily analyse the recent price movements of assets, such as stocks or other financial instruments. Momentum investors believe that assets with strong recent performance will continue to show strength, while those with weak recent performance will continue to lag.

• Relative strength analysis: Momentum investing often involves comparing the relative strength of one asset to another, or to a benchmark index. Assets exhibiting stronger relative strength may be favoured by momentum investors for long positions, while those with weaker relative strength may be considered for short positions.

• Short-term focus: Momentum strategies typically have a shorter investment horizon, with rebalancing periods usually shorter than one year. Momentum investors may frequently adjust their portfolios to capture the most recent trends, as the effectiveness of momentum is more likely to diminish over longer time periods. 

Ways to determine a trend

There are many different ways to define whether an asset is trending or not. Among the most popular are:

• Moving averages: Moving averages are commonly used to identify trends and smooth out short-term fluctuations in price. The two main types are the simple moving average (SMA) and the exponential moving average (EMA). When the price is consistently above a moving average, it may indicate an uptrend, while when the price is consistently below a moving average, it may signal a downtrend.

• Recent historical returns: For momentum investors, recent historical returns are an important indicator as to whether performance will repeat itself. It’s common for momentum investors to analyse returns of the past month, semester or year to determine if an asset is trending up or down.

• Technical indicators: Various technical indicators, such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD) and stochastic oscillators can help identify trends and potential reversal points.

Momentum investing hypotheses

There is no scientific way to prove if momentum investing works or not. Whether momentum investing is a strategy to embark on depends heavily on individual circumstances, risk tolerance and investment goals. It's essential to conduct thorough research, keep updated on market developments and be aware of the associated risks.

While numerous factors are always at play, modern economics has two competing hypotheses for why momentum could potentially achieve superior risk-adjusted returns relative to the broad market.

Behavioural explanations

Numerous behavioural explanations abound, but in the main, this hypothesis suggests that investors generally tend to under-react to positive news, and that investors are usually risk-averse, so it’s only natural that even good news for a company should bring some scepticism with it. Over time, this behaviour compounds, and those who stick with companies that had been doing well can possibly end up with superior returns.

Risk-based explanations

This hypothesis suggests momentum investors can potentially earn higher returns simply because they are taking on more risk. However, a momentum strategy will sometimes result in investors buying into overvalued stocks, until eventually momentum crashes.

How to implement a momentum strategy

There isn't a single best way to implement a momentum strategy as it depends on various factors like your investment goals, risk tolerance and financial expertise. It's crucial to understand that past performance is not indicative of future results and that investing in any asset carries inherent risks.

Momentum investors often debate about whether to use moving averages, recent returns and technical indicators to help make strategic decisions. Ultimately, if there’s a strong trend taking place, any utilised trend signal should be able to pick it up.

Momentum, however, is one investment strategy that tends to have a relatively high turnover. Whereas value investing usually has annual rebalances, or rebalancing periods over even longer time periods than that, momentum investing tends to have a pretty fast turnover, with positions generally remaining in a portfolio for less than six months or even shorter time periods, such as monthly.

The frequent turnover involved with a momentum investing strategy can be challenging for many investors, for whom using managed funds like ETFs could potentially be an option to consider.

Ten momentum ETFs

Data as of 01.03.2024 for share price, AUM and returns. Source: ETFdb.

The list of funds mentioned is ranked by assets under management (AUM). When deciding what ETFs to feature, we analyse the financials, recent news, the state of the industry and whether or not they are actively traded on Stake.

1. iShares Edge MSCI USA Momentum Factor ETF ($MTUM)

Assets under management: US$9.92b

Stock price (as of 01/03/2024): US$182.21

$MTUM focuses on large and mid-cap U.S. stocks exhibiting strong momentum characteristics. Tracking the MSCI USA Momentum Index, it rebalances twice per year. With an expense ratio of 0.15%, this fund is widely recognised for providing investors exposure to established U.S. companies with positive momentum, being the biggest ETF in the category.

2. iShares Edge MSCI International Momentum Factor ETF ($IMTM)

Assets under management: US$1.82b

Stock price (as of 01/03/2024): US$37.25

$IMTM extends the momentum strategy to international developed and emerging market equities, tracking the MSCI ACWI ex USA Momentum Index. It rebalances twice per year and charges an expense ratio of 0.30%, offering global diversification for investors seeking momentum exposure beyond U.S. borders.

3. Invesco S&P MidCap Momentum ETF ($XMMO)

Assets under management: US$1.58b

Stock price (as of 01/03/2024): US$106.74

$XMMO concentrates on mid-cap U.S. stocks with strong momentum, tracking the S&P MidCap 400 Momentum Index. Rebalancing twice per year, it boasts an expense ratio of 0.34%, providing investors with a targeted approach to capturing momentum in the mid-cap segment.

4. Invesco Dorsey Wright Momentum ETF ($PDP)

Assets under management: US$1.22b

Stock price (as of 01/03/2024): US$95.16

$PDP differentiates itself by tracking the Dorsey Wright Technical Leaders Index, selecting U.S. stocks with strong relative strength. Rebalancing quarterly, PDP carries the highest expense ratio on our list, charging 0.62%, offering an actively managed approach to capturing momentum within the U.S. equity market.

5. iShares U.S. Small‑Cap Equity Factor ETF ($SMLF)

Assets under management: US$925m

Stock price (as of 01/03/2024): US$61.17

$SMLF targets momentum within the U.S. small-cap equity space, tracking the MSCI USA Small Cap Momentum Index. Rebalancing twice per year and featuring an expense ratio of 0.15%, SMLF caters to investors seeking momentum exposure in the small-cap segment.

6. Invesco Dorsey Wright SmallCap Momentum ETF ($DWAS)

Assets under management: US$895m

Stock price (as of 01/03/2024): US$90.13

$DWAS concentrates on small-cap U.S. stocks with strong relative strength, tracking the Dorsey Wright SmallCap Technical Leaders Index. Rebalancing quarterly and with an expense ratio of 0.60%, DWAS is another fund that provides a focused approach to capturing momentum within the small-cap space.

7. Invesco S&P SmallCap Value with Momentum ETF ($XSVM)

Assets under management: US$738m

Stock price (as of 01/03/2024): US$54.63

$XSVM uniquely combines momentum and value factors within the U.S. small-cap space, tracking the S&P SmallCap 600 High Momentum Value Index. Rebalancing quarterly, it carries an expense ratio of 0.30%, aiming to capture both value and momentum premiums in the small-cap segment.

8. JPMorgan U.S. Momentum Factor ETF ($JMOM)

Assets under management: US$727m

Stock price (as of 01/03/2024): US$50.88

$JMOM targets U.S. large and mid-cap stocks displaying strong momentum characteristics, tracking the JP Morgan US Momentum Factor Index. Rebalancing twice per year and with an expense ratio of 0.12%, JMOM is the cheapest fund in this list and provides exposure to momentum factors through JPMorgan's quantitative approach.

9. Invesco S&P 500 Momentum ETF ($SPMO)

Assets under management: US$713m

Stock price (as of 01/03/2024): US$77.14

$SPMO concentrates on large-cap U.S. stocks with strong momentum, tracking the S&P 500 Momentum Index. Rebalancing quarterly and featuring an expense ratio of 0.13%, SPMO offers a straightforward approach to capturing momentum within the S&P 500.

10. Vanguard U.S. Momentum Factor ETF ($VFMO)

Assets under management: US$447m

Stock price (as of 01/03/2024): US$146.50

$VFMO targets large and mid-cap U.S. stocks with strong momentum characteristics, tracking the CRSP US Large Cap Momentum Index. Rebalancing twice per year and featuring an expense ratio of 0.13%, VFMO provides investors with a cost-effective option for accessing momentum within the U.S. equity market.

Pros and cons of momentum investing

Momentum investing, like any investment strategy, has its own set of advantages and disadvantages. It's essential to conduct thorough research, keep updated on market developments and be aware of the associated risks, and also consider individual circumstances, risk tolerance and goals. It's crucial to understand that past performance is not indicative of future results and that investing in any asset carries inherent risks.

Here are some potential pros and potential cons associated with momentum investing:

Pros

• Potential for high returns: Momentum strategies aim to capitalise on trends, and if those trends continue, investors can potentially achieve significant returns.

• Clear signals: Momentum strategies can provide clear buy and sell signals based on recent performance. This simplicity can be attractive to some investors.

• Quantitative approach: A momentum investing strategy can be implemented using quantitative models and technical analysis, which appeals to those investors who prefer systematic and data-driven approaches.

Cons

• Reversals and market volatility: One of the significant drawbacks of momentum investing is that trends can reverse suddenly, leading to potential losses. Market volatility can result in abrupt changes in asset prices.

• Overvaluation risk: Momentum investing may lead to buying assets that have already experienced substantial price increases, potentially leading to overvaluation. This can increase the risk of a correction or market pullback.

• Short-term focus: Momentum strategies often have a short-term focus, which may not align with the investment goals or time horizons of all investors. Short-term trading can also result in higher transaction costs.

• Market noise: Short-term price movements can be influenced by market noise, and distinguishing between noise and a genuine trend can be challenging.