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Momentum Investing in India: How It Is Practised, and Where It Hurts

Momentum investing buys what has already been going up, on a rule rather than a view. Here is how momentum is defined, how it is run in India, and its real risks.

By Altys Labs·

#momentum#factor-investing#systematic-investing#indian-markets#risk

Momentum investing means holding the securities that have gone up the most over a recent measurement window, decided by a rule rather than by a view on the business, and refreshing that list on a fixed schedule. The underlying claim is narrow and worth stating precisely: relative price strength over intermediate horizons has, in many markets and many periods, tended to persist a little longer than chance would predict. That is all it claims. It says nothing about whether a company is good, cheap, or well run.

In India, momentum has moved from an academic curiosity to something ordinary investors meet directly, through published momentum indices, index funds and exchange traded funds built on them, and a growing set of rule-based portfolio products. That makes it worth understanding as a method, including the parts that are uncomfortable.

What momentum actually measures

A momentum process has four moving parts, and almost every disagreement about momentum is really a disagreement about one of them.

The universe. The set of stocks eligible to be ranked. In India this is usually a liquid index universe, because momentum requires you to trade in and out, and illiquid names make that expensive or impossible.

The formation window. The period over which past return is measured. Common academic choices are six months and twelve months. Very short windows tend to pick up reversal rather than continuation, and very long windows blur into value effects.

The ranking rule. How raw past return is converted into a score. Many published methodologies divide the return by the volatility of returns over the same period, so that a steady climb ranks above a jumpy one that arrived at the same place. This is what people mean by risk-adjusted or normalised momentum.

The rebalance rule. How often the ranking is recomputed and the portfolio reset. Momentum decays, so the list has to be refreshed. Refresh it too often and costs eat the result. Refresh it too rarely and you hold stale winners.

For the mechanics of each of these steps in order, see the companion piece on how momentum is measured, which stays deliberately on method and names no securities.

How momentum shows up in Indian markets

Momentum reaches Indian investors through several channels, and they are not equivalent.

Published momentum indices. Indian index providers publish factor indices, including momentum indices built on large and mid cap universes. Their methodology documents are public, and reading one is the fastest way to see how a serious rule is specified: eligibility screens, the return windows used, the volatility adjustment, the number of constituents, weighting caps, and the review calendar. Whatever you think of the strategy, the documents are a good model of what a written rule should contain.

Index funds and exchange traded funds tracking those indices. These make a rule-based momentum exposure buyable in a single instrument, with the fund absorbing the rebalancing rather than the investor. The trade-offs are the usual ones for any passive vehicle: expense ratio, tracking difference, and on-exchange liquidity. Related reading on smart beta funds in India covers how to evaluate one.

Discretionary and rule-based managed products. Portfolio managers and alternative funds may run momentum as one signal among several, often blended with quality or low volatility filters to soften its worst behaviour.

Do it yourself screening. Plenty of individual investors compute a momentum rank themselves. This is where the method is most often applied loosely, with a window chosen because it looked good in a chart rather than because it was fixed in advance.

The rules that make or break the process

Momentum is unusually sensitive to implementation. Two investors running the same headline idea can end up with very different outcomes purely because of the plumbing.

Liquidity and impact. A momentum list rotates. If the names on it cannot absorb your order size without moving the price, the return you measured on closing prices is not the return you can capture. This is the practical ceiling on how far down the market cap ladder a momentum process can go, and it is covered in more detail under liquidity constraints in backtesting.

Turnover, cost and tax. Momentum is a high turnover approach by construction. Every rebalance triggers brokerage, exchange and statutory charges, and in a taxable account it also triggers capital gains events. Paper results computed without these are not comparable to a real account.

Corporate actions. Price history has to be adjusted for splits, bonuses and other actions before any return is computed. An unadjusted series will show a fake collapse on the ex-date and can throw a stock straight to the bottom or top of a momentum rank for no economic reason.

Concentration. Because momentum ranks on price behaviour alone, the resulting list often clusters in whichever sector has been leading. Nothing in the rule prevents a portfolio from becoming a single sector bet. Most serious implementations add caps at the stock and sector level for exactly this reason.

Rule fixity. The single most common failure is changing the window or the filter after seeing the result. At that point the process is no longer a rule, and the evidence for it is no longer evidence.

What momentum does not tell you

This is the section that matters most, and it is the one usually left out.

It says nothing about value. A momentum rank is indifferent to what you pay. A stock can be at the top of the list at any valuation. Nothing in the signal protects you from buying an expensive asset late in its run.

It says nothing about the business. Earnings quality, balance sheet strength, governance, promoter pledging and management credibility are all invisible to a price-based rank. Momentum can and does pick up stocks whose price is rising for reasons that have nothing to do with durable economics.

It has a specific and ugly failure mode. Momentum portfolios have historically been prone to sharp reversals when a falling market turns, because the positions that benefited most from the prior trend unwind at the same time. This is often described as a momentum crash. It is not a rare theoretical possibility; it is the characteristic risk of the approach, and it is why factor cyclicality and drawdowns is essential companion reading.

It goes through long droughts. Any factor can lag for years. A momentum process that is abandoned during a drought captures the pain without the recovery, which is a behavioural risk as much as a statistical one.

Published evidence is not a forecast. Studies of past factor behaviour describe what happened in a sample, under a particular set of definitions, usually before costs. They are not a statement about what will happen next, and no amount of historical documentation changes that.

Your measurement may be flattered. If a momentum study is run on today’s index membership, it silently excludes companies that were delisted or removed, which is survivorship bias. If it uses data that was not knowable on the ranking date, it is contaminated by lookahead. Both make momentum look better than it was.

Momentum is a rule about price, applied to a universe, on a schedule, at a cost. Change any one of those four and you have a different strategy, whatever you call it.

A reasonable way to think about it

Momentum is best understood as one measurable characteristic of a portfolio rather than a complete investment philosophy. It can be measured, it can be sized, and it can be constrained. What it cannot do is substitute for a view on what you own or for an honest accounting of costs. Investors who use it well tend to write the rule down before they run it, size it as one exposure among several, plan for the drawdown in advance rather than during it, and measure results after costs rather than before.

This article is educational. Altys Labs is not a registered research analyst or investment adviser, and nothing here is investment advice or a recommendation to buy, sell, or hold any security.

Frequently asked questions

What is momentum investing?

Momentum investing is the practice of ranking securities by their recent price performance and holding the strongest, then re-ranking on a fixed schedule. It is a rule about relative price behaviour, not a judgement about business quality. The claim behind it is that recent relative strength has tended to persist over intermediate horizons more often than chance would suggest.

Does momentum work in Indian markets?

Academic and index-provider studies have documented momentum effects across many equity markets, including India, but the effect is noisy, varies by period, and goes through long stretches where it lags. Any honest answer has to include the fact that documented past behaviour is not a promise about future behaviour, and that costs and taxes reduce whatever is measured on paper.

Why is momentum considered risky?

Momentum portfolios concentrate in whatever has recently run, so they can become crowded in a few sectors. They also suffer sharp reversals when the market turns, a pattern often called a momentum crash, because the positions most exposed to the previous trend unwind together. High turnover adds cost and tax drag on top.