Fundamental and value investors use corporate earnings analysis as one of the driving factors to select investment with the highest potential. However, another class of investors is not particularly concerned with either intrinsic value or earnings, but instead is focused purely on the stock price and which direction it is heading.

Momentum-driven investors frequently are looked down on by fundamental analysts, who see them as “dumb” money. But as we saw in a , there is pretty strong evidence that buying past winners and selling past losers is a profitable strategy over the long term. There are a few fundamental reasons stock prices might not be totally random, but instead tend to “trend” at important times:

  1. It can take a long time for large institutional investors like mutual funds and pension funds to enter into positions in a stock. This is because they are managing so much money that they need to space out the time period in which they buy a new stock in order not to flood the market with “buy” orders and make the price go up.


  1. Professional investors tend to “herd” together for various reasons (either they are directly sharing ideas, or it is just the professionally safe path to take because if the stock you buy goes down, at least you can claim that plenty of other people made the same mistake). Once one big fund accumulates a position, pushing the price up in the process, others are likely to follow.


  1. New information may not be instantaneously incorporated into the stock price. If, for instance, a company’s new products are selling far better than anyone expected, different analysts may figure this out at different times. This can create sustained buying pressure on a stock.


  1. Somebody may have non-public information. The first buyers in a trend may be analysts with inside information, or company insiders who know something is up. These first buyers cause the stock price to go up initially. Once the news travels, the price continues to go up until the information is completely reflected.


  1. Once a stock has gone up a lot (for any reason), momentum investors will flood in and purchase its shares, pushing it up even more. In this sense, momentum can be a self-fulfilling phenomenon (the mere fact that a lot of people think it exists reinforces that view).