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Momentum refers to the empirically verified tendency for securities that are rising to continue to rise and securities that are falling to continue to fall. Over the long term, securities with higher levels of momentum typically outperform the market, the so-called momentum premium.
Momentum investing tries to capitalise on the continuance of existing trends in the market, by taking a long position in an asset that is upward trending or shorting a security that has been falling.
Since price trends are temporary and tend to mean-revert over time, most momentum strategies focus on a six- to 12-month horizon. Momentum can be vulnerable to periods of volatility, and high turnover and transaction costs, which can diminish alpha.
Unlike the size premium which has eroded since it was first identified, the momentum factor has performed consistently over time and remained profitable over the past 40 years, which many attribute to the behavioural tendency of investors to overreact or underreact to news.
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