10 momentum stocks outpacing the market

Having delivered consistently robust returns over the past six years, Stockopedia's Ben Hobson reruns this trading strategy and finds the best momentum plays right now.

The American fund manager Richard Driehaus rejected the traditional stockmarket mantra of buying low and selling high. Instead, he believed there was far more money to be made by buying high and selling at even higher prices.

Driehaus was one of the early proponents of what's known as momentum investing. He went on to earn guru status by showing (through his fund performance) that momentum was profitable in the real world - and not just in academic research.

In investing, momentum is the tendency for price trends to persist. It causes securities with rising prices to rise further, and securities with falling prices to fall further. Like other factors such as 'value' and 'quality', momentum has a track record of being a powerful driver of stockmarket profits.

Over the past 30 years some of the smartest minds in finance and money management have explored momentum in detail. They've also come up with various strategies that try to capture it. But while many of the strategies have proved to be powerful, there’s still a debate about why momentum exists at all...

Momentum triggers

Some believe that just like value investing, there's a risk premium attached to momentum. In other words, momentum profits only exist because there are times when the strategy doesn’t work at all. It’s well known that momentum can crash periodically (it did spectacularly in 2009) so investors are wary of it, and they demand a premium from it as a result.

An alternative, and much more accepted view of momentum is that it is driven by investor behaviour. More specifically, it's caused by investor underreaction and delayed overreaction. With underreaction, prices are slow to react to news because investors are either cautious, not looking or can’t trade. But with delayed overreaction, investors chasing rising prices attract the attention of the investing herd, who follow them into those trades, pushing prices higher and higher. 

Chasing price momentum

One of the most straightforward momentum strategies is one devised by the researchers Narasimhan Jegadeesh and Sheridan Titman. It focuses solely on a stock’s price strength relative to the rest of the market. They found that momentum often lagged for the first month but then accelerated over the subsequent six to 12 months. 

Jegadeesh and Titman wrote:

"The strategy we examine in most detail, which selects stocks based on their past six-month returns and holds them for six months, realises a compounded excess return of 12.01% per year on average."

This strategy is one of several momentum screens tracked by Stockopedia, and we've generally seen consistently robust returns from it over the past six years - with a 32.4% gain seen over the past 12 months.

Source: Stockopedia      Past performance is not a guide to future performance

Here is a selection of UK stocks currently passing these price momentum rules.

Source: Stockopedia      Past performance is not a guide to future performance

Momentum strategies are often a good barometer of sector trends and popularity in the market. As such these results show that mining stocks in particular have benefitted from strong momentum over the past year. Among them are groups like Griffin Mining Ltd, EVRAZ and Anglo American. Others making the list include software firm LoopUp Group, energy group Genel Energy, business brokerage K3 Capital Group and IT reseller Softcat.

While the stocks on this list have all performed well over the past year, it’s important to remember the risks with pure momentum strategies. 

Trading on the behaviour of other investors means investing in shares that can end up on stretched valuations. If those companies slow down or if sentiment changes towards them, their share prices can come crashing down. 

For that reason, many momentum investors introduce quality or valuation filters to reinforce their strategies. But, on its own, momentum has proved to be a powerful driver of market returns. It can be a useful pointer to the market’s strongest performing stocks and it has a performance track record that’s hard to ignore.

About Stockopedia

Stockopedia helps individual investors beat the stock market by providing stock rankings, screening tools, portfolio analytics and premium editorial. The service takes an evidence-based approach to investing, and uses the principles of factor investing and behavioural finance to help investors make better decisions.

Interactive Investor readers can get a free 14-day trial of Stockopedia byclicking here.

These investment articles are simply for generating ideas. If you are thinking of investing they should only ever be a starting point for your own in-depth research.