Does Buy & Hold Strategy work in Momentum Investing ?

Momentum investing is a popular strategy that capitalizes on the tendency of stocks with upward trends to continue performing well. Investors buy stocks that have been rising in price and sell those that have been falling, aiming to ride the wave of positive momentum.

However, new research suggests that simply buying and holding onto momentum stocks may not be enough

The study, conducted by Rajan Raju and Abhijit Chandrasekaran (2019), investigates the persistence of momentum in the context of the NIFTY 100 index in India. Their findings highlight the crucial role of rebalancing in a momentum portfolio.

The Fading Power of Momentum

The research confirms that momentum exists in the short term. Stocks with strong past performance tend to outperform in the following months. But interestingly, the study reveals that this advantage diminishes over time. By the end of the year (around 12 months), the difference in performance between momentum winners and losers becomes statistically insignificant.

Why Does Momentum Fade?

The authors attribute this fading momentum to investor behavior. They suggest that investors tend to overreact to news and information in the short term, driving up the prices of winning stocks. However, this enthusiasm wanes over time as the news is digested and factored into the stock price. Conversely, initially underperforming stocks may see a recovery in price as investors adjust their overestimation of the bad news.

The Importance of Rebalancing

The key takeaway for momentum investors is the importance of rebalancing their portfolios regularly. The study demonstrates that a momentum portfolio left unadjusted will eventually lose its edge. Here’s why rebalancing is crucial:

• Maintains Momentum Focus: Rebalancing ensures your portfolio stays tilted towards stocks with current momentum. As some initial winners lose their momentum, rebalancing allows you to replace them with new outperformers.
• Reduces Risk: By selling off inflated stocks and reinvesting in undervalued ones, rebalancing helps manage risk within the portfolio.

The Sweet Spot for Rebalancing

The research by Rajan Raju and Abhijit Chandrasekaran doesn’t explicitly recommend a specific rebalancing frequency. However, considering their findings on momentum fading over 3 months to be quite drastic , a reasonable strategy would be to rebalance more frequently than that.

We can infer a sweet spot for rebalancing a momentum portfolio to be between 1 week and 3 months.

This timeframe allows you to capture short-term momentum shifts while avoiding excessive trading activity and associated costs. The ideal frequency for you will depend on your risk tolerance and the volatility of the specific stocks you hold.

Here’s how the chosen timeframe impacts rebalancing:

• More Frequent Rebalancing (1–2 weeks): This approach helps you stay very close to the current momentum leaders. However, it can also lead to more frequent trading activity and associated costs (commissions, fees).
• Less Frequent Rebalancing (2–3 months): This strategy allows for some portfolio drift but reduces trading costs.

You can watch our detailed video explaining on the methodology of their research here

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