Will the Compass PLC (LON:CPG) share price keep heading in the right direction?

Food service group Compass (LON:CPG) recently reported that its new financial year had got off to an "excellent start". As a result, the food service group said it expected to be slightly above the middle of its target 4-6% organic growth range for the full year. 

Finding stocks that deliver this kind of upbeat earnings guidance is a key part of a price momentum strategy used by some of the world’s most successful traders. 

Indeed, knowing the factors that drive relative strength in share prices can help you find profitable momentum trades, too. I’m going to use Compass (LON:CPG) as an example of how this can work.

How has the Compass (LON:CPG) share price performed?

Compass is a conservative, large cap in the Restaurants & Bars industry and it has a market cap of £27,440m.

Over the past year, the Compass share price has risen by 12.6%, which sounds pretty good.

In fact, when you consider that the FTSE All-Share index actually fell over the past year, Compass has actually done better than it seems. Its shares have a 1-year relative strength of 13.2%.

Why relative strength really matters

Relative strength is a crucial tool in the armoury of technical traders and investors. It’s an instant measure of how a stock has performed in comparison with a benchmark. And it tells you instantly whether the market likes what it's seeing.

And while there are no certainties about which way a stock will move next, research shows that price trends often persist.

Studies by Narasimhan Jegadeesh and Sheridan Titman, who are leading experts on momentum, show that stocks with the strongest price strength tend to keep up the pace for anywhere up to one year.

But what causes this?

The answer is that investor behaviour plays a big role. Academics point to two key drivers:

• Under-reaction - prices are slow to move up because investors are hesitant to bid prices higher in stocks that have already been on a strong run.

• Delayed over-reaction - investors chasing rising prices attract the attention of other investors, who follow them into those trades, pushing prices higher and higher.

So the answer is that momentum in stocks with strong relative strength is at least partly caused by a virtuous circle of human emotion. Investors have to constantly re-price these improving shares in their own minds. 

It won’t always happen - and it might take some time - but when momentum takes over, it can push prices higher and higher.

What does this mean for potential investors?

Compass is currently among the stocks with the strongest six-month and one-year relative price strength in the market. But momentum on its own is no guarantee of future returns. 

To get a better idea about whether this momentum will continue, it's worth doing some investigation yourself. Indeed, we've identified some areas of concern with Compass that you can find out about here.