Momentum Trading Strategy

From Financial Literacy Wiki

Momentum Trading Strategy is similar to Value Investing that exploits market inefficiencies but the assumption is that the market follows the weak-form version of it. Early testing of this strategy is by looking at autocorrelation of stock returns over short intervals of time, say daily, weekly or monthly. Positive autocorrelation of daily returns implies that positive returns today tend to be followed by positive returns tomorrow and vice versa. So if the return's autocorrelation is strong then investors may be able to earn superior returns simply by using past returns as predictors of future returns.

The momentum trading strategy is designed to exploit the positive autocorrelation in stock returns. The profitability of momentum trading strategy has been investigated for most markets and it is found that the trading strategy works better in emerging markets compared to developed markets. These results suggest that emerging markets are less efficient than developed markets.