Momentum investing in India: a plain-English guide

Momentum investing buys what has been rising and avoids what has been falling, on the idea that trends tend to persist for a while. It is one of the most studied market effects, and also one with real risks.

The idea

Stocks that outperformed over the past 6 to 12 months have, in many markets and periods, kept outperforming over the next few months. Researchers often call it the momentum factor. In India, NSE publishes momentum-based indices, and several index and mutual funds follow the approach.

How it is built

A simple version ranks stocks by past returns, holds the top group, and rebalances on a schedule. The scanner’s RS rating is built the same way, blending 3, 6, 9 and 12-month returns.

The risks

• Momentum crashes: sharp reversals, often when markets rebound from a fall.
• Costs and tax: frequent trading adds brokerage, impact cost and short-term capital-gains tax.
• Crowding and regime change: the effect varies over time and may weaken.

Testing without hindsight

A backtest must use only what was known on each date, including which stocks existed and how liquid they were. The momentum backtest guide explains how the scanner does this, with costs and Indian tax included.

A worked example

Rank 500 stocks by a blend of 12-, 6-, 3- and 1-month returns. Hold the top 25, equal weight. At each month-end, sell stocks that fell out of the top 50 and buy new top-25 names. With 25 positions and a 20% monthly turnover, a trader makes about 10 transactions a month. Brokerage, impact cost and short-term capital-gains tax reduce the result, so costs must be part of any test.

Strategy examples

These are illustrative rule sets that show how the scanner can be used. They are not recommendations or advice, the numbers are examples, and rules like these can lose money. Test any idea on your own and manage risk before acting.

Top-N with scheduled rebalance

1. Choose a universe such as liquid Nifty 500 stocks.
2. Rank by blended past returns.
3. Hold the top N (for example 20 to 30) in equal weight.
4. Rebalance monthly or quarterly; use a buffer so small rank changes do not trigger trades.

Trend filter plus ranking

1. Only hold stocks above their 200-day average.
2. If the market index is below its 200-day average, hold fewer stocks or more cash.
3. Backtest the rule with costs and tax, and compare to a simple index.

Position limits

1. Cap any single stock or sector at a fixed percentage.
2. Limit the number of new buys in one month.
3. Test whether the caps help or hurt in the backtest before using them.

Common mistakes

• Ignoring costs and taxes in the test.
• Picking parameters because they fit the past best.
• Abandoning the rule during a drawdown, which momentum strategies often have.
• Using only a few stocks, which makes results depend on luck.

Frequently asked questions

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