Investors often search for an edge in identifying which stocks or asset classes are poised to outperform. While no strategy guarantees success, two approaches that have stood the test of time in academic research and professional practice are relative strength and momentum investing.
What Is Relative Strength?
Relative strength measures how a stock or asset is performing compared to a broader market index or to other securities. Instead of asking, “Is this stock going up?” relative strength asks, “Is this stock going up more than others?”
For example, if Stock A has gained 10% over the last six months while the market rose 5%, Stock A exhibits relative strength. Investors often look to overweight securities that consistently lead the pack, with the idea that strength today may signal continued leadership tomorrow.
Relative strength doesn’t predict turning points or bottoms, Instead, it focuses on identifying persistent leadership, helping investors tilt toward areas of the market that are already showing durability.
What is Momentum Investing?
Momentum is closely related but slightly different. While relative strength investing compares on security to another, momentum looks at the persistence of a trend in a single investment over time.
Research has shown that securities that performed well over the last 3-12 months often continue to perform well in the near term, while laggards tend to keep lagging. This “trend-following” behavior exists across asset classes: stocks, bonds, commodities, and currencies.
Momentum strategies typically involve ranking securities by past returns, then holding the leaders for a period before re-evaluating. The process is systematic, aiming to capture the tendency of winning investments to keep winning….at least for a time.
Why Do These Approaches Work?
Both relative strength and momentum tap into behavioral financial principles:
- Investor psychology: People often chase winners late and sell losers too early, creating trends that persist longer than fundamentals alone might justify.
- Market inefficiencies: Institutional constraints and risk aversion can cause underreaction to new information, allowing momentum to build gradually.
Importantly, these approaches are not about speculation or “hot tips.” They are disciplined frameworks for identifying leadership in markets and positioning portfolios accordingly.
Practical Considerations
Relative strength and momentum strategies require rules and discipline. That means:
- Defining time frames (e.g., six-month or twelve-month lookbacks).
- Diversification to avoid concentrated bets in just one sector.
- Rebalancing schedules to keep the portfolio aligned with the strategy.
- Risk management so that no single position dominates outcomes.
Like any strategy, there will be periods when momentum underperforms. Investors must be prepared for stretches of lag before trends reassert themselves.
Final Thoughts
Relative strength and momentum investing are about following evidence, not emotions. Instead of trying to guess turning points or pick bottoms, these approaches lean into what is already working. For investors, that can mean aligning portfolios with leadership trends while avoiding prolonged exposure to underperformers.
While no strategy should stand alone, combining momentum insights with a broader financial plan can add a valuable dimension to long-term wealth management.
Want to explore how momentum investing fits into your financial goals? Schedule a conversation with one of our advisers to review your portfolio and discuss strategies tailored to your needs.