Stock momentum is the concept that a stock that has performed well recently will continue to perform well, and that a stock that has performed poorly will also continue to perform poorly. Behaviorally, people tend to hold on to and buy stocks that have consistently appreciated (even when a company has a disappointing quarter). Similarly, a stock that continues to plummet tends to cause a panic, resulting in more people selling so that the price falls in a downward spiral. While this signal does not always hold, it is still a valuable indicator, especially when used in conjunction with others.
Momentum investors seek to take advantage of upward or downward trends in stock prices. They believe that these stocks will continue to head in the same direction because of the momentum that is already behind them. This theory relies on the belief that there are a large number of investors in the market who will buy whatever stock is already hot. Momentum investors do not necessarily believe that momentum stocks will do well in the long run, but they do think that in the short to medium run they will out perform.
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2. Vayanos, Dimitri and Woolley, Paul, “An Institutional Theory of Momentum and Reversal” (November 2008). View2
4. J.P.Morgan, “Price Patterns and Chaos Theory in Volatile Markets” (February 2009).