What it is
Momentum trading buys what has been going up and sells or avoids what has been going down, on the empirical finding that relative performance persists over medium horizons. It comes in two forms: cross-sectional momentum, which ranks a universe and holds the leaders against the laggards, and time-series or absolute momentum, which trades each instrument against its own past return.
How it works
The academic formulation ranks equities on the previous twelve months of returns while excluding the most recent month, since the skip avoids short-term reversal, and rebalances monthly. Systematic trend followers apply the time-series version to futures with moving-average or breakout rules and volatility-scaled sizing. Retail versions substitute MACD, moving-average slope or relative-strength screens, but the underlying bet is the same.
How traders use it
The effect has been documented across equities, indices, currencies and commodities and over many decades of data, which makes it one of the most persistent anomalies known. Explanations divide between behavioural accounts, such as under-reaction to news followed by herding, and risk-based ones, and that argument remains unresolved, which is itself a reason for humility about how durable the effect will prove.
Where it breaks down
The costs are real. Momentum has a low win rate and depends on a fat right tail, so long flat or losing stretches are normal and psychologically difficult. It suffers sharp momentum crashes when a downtrend reverses violently, because the portfolio is positioned exactly wrong at the turn. Turnover is high, so implementation costs matter, and crowding into the same widely published ranking rules can compress the edge further.
Educational reference. This entry describes how a concept is defined and used. It is not investment advice, not a recommendation, and not a signal. Any rule you build from it should be tested with realistic costs before it is traded, and no historical result guarantees a future one.