This blog post is fourth in a series of posts called – “All You Need To Know About Different Investing Strategies“.
Momentum investing is all about cashing in on trends in the market. The basic premise centers on buying stocks whose prices are on the rise and selling off those that are in decline.
Assuming that the trend continues, momentum investing makes it easier to predict which investments are likely to yield the biggest returns.
Essentially, investors who go this route bank on securities to keep their winning streak intact.
Momentum investing is an entirely different animal and it’s geared toward investors who prefer active to passive investments. It’s a simple but powerful idea confirmed by hundreds of studies.
Investors who are into momentum investing specialize in taking advantage of existing market trends. By seizing the moment, they are able to make higher than the standard profits.
Should You Invest in Value Stocks?
As a stock’s price goes up, so do the gains and it’s the opposite when the value goes down. So why would a savvy investor want to go the momentum route?
It all comes down to the kind of returns this strategy can produce. Momentum investing is like playing a game of hot potato. The biggest risk for investors is a reversal of a stock’s current trend. This can be especially
problematic, if they’re concentrating a significant amount of their investments in specific sectors, such as finance, energy or biotech.
The momentum investing approach isn’t right for every investor. If they’ve trained their eye to spot trends, momentum investing makes it possible to not only match the market but beat it. Timing and patience play a big part in whether or not investors are able to achieve success
How to Invest in Momentum Stocks?
Once investors have created their dynamic stock list using one or multiple expert stock screens, the next most critical question is when should they buy those stocks?
Most people can’t resist a good bargain and rush out to buy supposedly attractive stocks only to experience their new holdings decreasing in value.
Often, a common mistake is a failure to look at the general trend of each stock before investing. One of the most important investment rules is: “Always go with the trend” or, as they say, “the trend is your friend”. The option of not going with the trend is comparable to swimming against the stream. It’s generally a bad idea.
They should only buy stocks when they are trending upwards, then selling them without delay at the first sign of weakness or price decline. Selling needs to be well-timed because that is where the concept is anchored upon.
Momentum Investing Methodologies
Momentum investing can be accomplished by two two borad means. Further in the blog we will discuss the options you have and nuances of each.
Relative Momentum
The
Relative Momentum Index function determines the internal momentum of a field
using the number of upward and downward price changes across a given number of
bars over a given period of time. The Relative Momentum Index is based on a
ratio of the average upward changes to the average downward changes over a
given period of time. The individual changes are calculated for the given
number of days. This is an extension of the Relative Strength Index, which uses
a momentum period of 1 to calculate day-to-day changes.
Absolute Momentum
Absolute
Momentum does not rank stock in relation to other but identifies the direction
and strength of momentum. It compares stocks current momentum to its past
momentum and tells when a stock has started momentum phase and when it ends it.
It tell momentum phase and as well the velocity of the momentum move. If the
absolute momentum is positive, then the trend is up. If absolute momentum
is negative, the trend is down.
How to Identify Momentum?
This is a very basic version of the philosophy, its not a strategy. We can discuss strategies in other blogs at a later time.
Momentum in
technical analysis is the rate of change of security prices or market indexes.
Usually, closing prices are used to calculate momentum.
Momentum!
$$Momentum = { Current Stock Price \- Earlier Price }$$
The earlier price can be any earlier price, but typically, the price 14 trading days earlier is chosen. An important point to remember and to prevent confusion is that if momentum is nonzero, then it has momentum, even if the difference is the same every day. In other words, the rate of change simply refers to the difference between the current price and the earlier price, even if the difference isn’t actually changing from day to day. Momentum equals zero when the current price is the same as the earlier price, and it is negative when the current price is less than the earlier price.
Famous Investors Associated with Momentum Investing
He is a momentum investing guru that has been hailed as one of the key
investment influencers of the last century, founded Driehaus Capital Management
on back of equity investment philosophies and strategies
Richard J. Dennis (born 1949) made his mark in the trading world as a highly successful Chicago-based commodities trader. He reportedly acquired a $200 million fortune over ten years from his speculating. Along with partner William Eckhardt, Dennis was co-creator of the mythical Turtle Trading experiment.
Ø Paul
Tudor Jones II (born 1954) is the founder of Tudor Investment Corporation, one
of the world’s leading hedge funds. Tudor Jones gained notoriety after making
around $100 million from shorting stocks during the 1987 market crash.
He used aggressive tactics to build his astounding wealth, and persists,
to this day as one of the biggest and most influential names in the investment
world.
Final Thoughts
With momentum investing, knowing when to sell is even more important than knowing when to buy. So, to succeed in momentum investing, investors need to have a mechanism that will tell them when it is time to buy and when to sell. While a few investors might claim or boast that they have such a mechanism, it is more of an exception than a rule. The truth is that there is no full-proof method, which can tell them when to enter and when to get out of the momentum cycle with a reasonable degree of certainty. Success in momentum investing requires a very high degree of skill combined with a higher level of fortune.
With a series of blogs on various investing styles, we have tried to make the reader comfortable with the idea of systematic investing and inculcate a tendency to follow a process in this fruitful journey.
Whether you’re new to investing or already have a plan in place, you can rely on TradeGyani for trusted advice on building your financial future.
