Momentum in investing: what it is and how it is calculated (1, 3, 6 and 12 months)
Momentum is the tendency of assets that have risen to keep rising (and those that have fallen to keep falling) for a while. It is one of the most studied investment factors since Jegadeesh and Titman documented it in 1993, and it is the basis of strategies such as HAA, BAA or Dual Momentum.
Why it exists (and why it can stop working)
The most common explanations are behavioural: investors react slowly to news, follow the herd or are slow to sell what is falling. There is no guarantee that the effect will persist; in fact, it suffers in sharp trend reversals ("whipsaws").
How an ETF's momentum is calculated
There are many formulas. The most used in these strategies:
The N-month return
return = today's price / price N months ago − 1. Always with prices that include dividends (total return).
The 1-3-6-12 average (HAA)
The simple average of the returns over 1, 3, 6 and 12 months. It gives weight to both the recent trend and the underlying one.
Example. An ETF has these returns: 1 month +2%, 3 months +4%, 6 months −1%, 12 months +9%. Momentum = (2 + 4 − 1 + 9) / 4 = 3.5%.
The 13612W (BAA)
A weighted average that gives more weight to the short term: (12·r1 + 4·r3 + 2·r6 + 1·r12) / 19. It reacts faster, at the cost of more false alarms.
Price versus its 12-month moving average (BAA)
Current price / average of the last 13 monthly closes − 1. A slower measure.
Relative and absolute momentum
- Relative: compares assets with each other. "The S&P 500 has done better than emerging markets, I buy the S&P 500".
- Absolute (or trend): compares an asset with its own past or with cash. "If the asset has negative momentum, I do not buy it and stay in cash".
Dual momentum (Antonacci) uses both. HAA does too.
Where it fails
- Sharp trend reversals: if the market falls and rebounds quickly, momentum takes you out at the bottom and puts you back in late.
- Sideways markets: many false signals, many commissions.
- Tax on rotation: selling assets at a gain to buy others may be taxed.
How to see it in practice
On the HAA Balanced sheet we show every month the momentum table for the 8 assets, with the 1, 3, 6 and 12-month returns and the resulting average.
Frequently asked questions
Which momentum period is best?
None is universally better. Periods of 3 to 12 months are the most studied; mixing several (as in HAA) softens the dependence on a single window.
Do I have to use dividend-adjusted prices?
Yes. With unadjusted prices, assets that pay dividends (bonds, real estate) would look worse than they are.
Does momentum work in all assets?
It has been documented in stocks, bonds, currencies and commodities, but with varying strength and stability. There is no guarantee.