The momentum effect: what is it?
The momentum effect refers to the tendency of stocks that have performed well over the last 3 to 12 months to keep outperforming in the short term. Conversely, underperforming stocks tend to keep underperforming.
This phenomenon was first documented by Jegadeesh and Titman (1993) and remains one of the most robust and exploitable market anomalies. It is mainly explained by:
- The slow reaction of investors to good news (initial under-reaction)
- The bandwagon effect — investors follow the trend (confirmation bias)
- The gradual diffusion of information across the universe of less-followed small caps
On small caps: the momentum effect is particularly strong because analyst coverage is thin (few analysts, few institutions). A strong set of results can take several weeks to be fully priced in — creating a window of opportunity.
Relative performance — the primary indicator
Momentum is measured first and foremost by a stock's relative performance versus a benchmark index over 6 or 12 months:
| 6-month relative performance | Interpretation | Momentum score |
|---|---|---|
| Outperforms by > +10% | Strong momentum — buying flows, positive catalysts | High |
| In line with the index (±5%) | Neutral momentum | Medium |
| Underperforms by > −10% | Negative momentum — selling pressure, negative catalysts | Low |
In the ML screener, 6-month relative performance versus the small-cap benchmark is the most heavily weighted feature in the Momentum pillar.
RSI — Relative Strength Index
The RSI (Relative Strength Index) is a technical oscillator that measures the speed and magnitude of price changes. It oscillates between 0 and 100:
| RSI (14 days) | Signal | What it means for the investor |
|---|---|---|
| > 70 | Overbought | The stock has risen quickly — risk of consolidation. Wait for a pullback before entering. |
| 50 – 70 | Positive momentum | Ideal zone — uptrend without excess. Favourable entry zone. |
| 30 – 50 | Neutral / Weak | Neutral or recovering momentum. Watch for a rebound above 50. |
| < 30 | Oversold | The stock has fallen a lot — a rebound is possible but the downtrend needs confirming. |
Interpret your RSI
MA50 and MA200 moving averages
Moving averages smooth out price fluctuations to reveal the underlying trend. The two reference levels are:
- MA50 (50 trading days ≈ 2.5 months): medium-term trend
- MA200 (200 trading days ≈ 10 months): long-term trend
| Configuration | Signal | Interpretation |
|---|---|---|
| Price > MA200 > MA50 | Strongly bullish | Uptrend across all horizons — very favourable momentum |
| Price > MA200 and Price > MA50 | Bullish | Confirmed long-term uptrend |
| Price between MA50 and MA200 | Neutral / Consolidation | Intermediate zone — wait for a break out of the range |
| Price < MA50 and Price < MA200 | Bearish | Downtrend — avoid or trim |
The Golden Cross and the Death Cross
Two moving-average crossover patterns are watched by many institutional traders:
- Golden Cross: the MA50 crosses above the MA200 → bullish signal, entry signal
- Death Cross: the MA50 crosses below the MA200 → bearish signal, exit signal
The Momentum pillar in the ML screener
The Momentum pillar accounts for 25 points out of 100 in the Screener Small Caps composite score. It aggregates four indicators:
These four signals are also direct features in the XGBoost model used to predict 12-month outperformance.
Momentum alone is not enough: a stock with strong momentum but poor fundamentals (EV/EBITDA > 20, high debt) is a risk. The screener combines all 4 pillars — an ideal stock has good fundamentals AND good momentum. It is this convergence that generates the best performance.