Momentum Factor

Momentum Factor

Investing based on market returns? Consider the Momentum Factor.

Why can't athletes stop as soon as they cross the finish line? Newton's first law of motion explains how the force used to reach the finish line becomes momentum and keeps them traveling in the same direction for a while even after the force is discontinued. A vector quantity, momentum includes both speed and direction.

This phenomena is fairly common in the stock market as well, when the movement of stocks develops momentum in reaction to a consistent force (buying or selling). Even after the initial impetus has diminished, this momentum keeps the stock price moving in the same direction. In other words, the momentum effect is the tendency for stocks that are already rising (or falling) to keep rising (or falling).

In factor investing, there are two momentum approaches. The first is time-series momentum, also known as absolute momentum, is estimated using a stock's own historical return. The second is cross-sectional or relative momentum which compares a stock's momentum to that of other stocks.

There are many choices regarding the time period for analyzing momentum. A single time period can be used or more than one time period to detect change in momentum.

Momentum Measured

There is an abundance of methodologies for momentum strategies, all backed by professionals and academicians.

The table below provides an overview of common momentum factor indices among index providers and professionals.

Index Details Factor Characteristics Methodology
Index Name: S&P 500
Momentum Index (US) Index Provider: S&P
Dow Jones Indices LLC
12-month price change excluding current month (9-month price change if 12-month data unavailable) Tilt S&P 500 Index (capitalisation- weighted) towards its constituents with weights equal to the product of their market capitalisation weights in Parent Index and Momentum Z-Score
Index Name: MSCI
India Momentum
Index Provider: MSCI
Risk-adjusted Price Momentum (6-month and 12-month) = [(6/12-month Price Return - Local Risk-free Rate)/SD of returns] Tilt MSCI India Index (capitalisation-weighted) towards securities based on their Momentum
Z-scores with weights equal to the product of Momentum Z-scores and their market capitalisation weights in the Parent Index
Index Name: Nasdaq
Factor Family US
Momentum Index Index Provider:
Nasdaq, Inc.
Momentum Strength Score = Sigma(Ret1,Ret3, Ret6, Ret9, Ret12)/5 50 securities with lowest Adjusted Momentum Strength Score are selected from the eligible universe, subject to a set of constraints
Index Name: Nifty 200
Momentum 30 Index Index Provider: NSE
Indices Ltd
6 and 12-month Momentum Ratio (excluding rebalancing month prices) = 6/12-month Price Return/(Ann. SD of lognormal daily returns of the stock for 1 year) Select top 30 stocks from Nifty 200 (capitalisation-weighted) based on their Normalised Momentum Z-scores. Security weights equal the product of their free-float market capitalisation and Normalised Momentum Score

Source: FTSE Russell, MSCI Inc, S&P Dow Jones Indices LLC, NSE Indices Ltd & Nasdaq, Inc. 

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