What is momentum investing?
Momentum investing is an investment strategy aimed at purchasing securities that have been showing an upward price trend or short-selling securities that have been showing a downward trend. The main rationale behind momentum investing is that once a trend is well-established, it likely to continue.
Momentum investing is an investment strategy aimed at purchasing securities that have been showing an upward price trend or short-selling securities that have been showing a downward trend. The main rationale behind momentum investing is that once a trend is well-established, it likely to continue.
Momentum investing can work, but it may not be practical for all investors. As an individual investor, practicing momentum investing will most likely lead to overall portfolio losses.
Momentum investing involves going long on stocks, futures, market exchange-traded funds (ETFs), or any financial instrument showing upward-trending prices and short the respective assets with downward-trending prices.
Please note that past performance is not a guarantee of future results and there is no sure way to predict stock market movement. Momentum investing also carries some cons such as high volatility, overvaluation and lack of fundamentals.
Momentum Investing Example: PepsiCo
Investors who got in at $164 would have enjoyed 9.75% gains in less than three months. The graph above shows PepsiCo stock's price performance from mid-May to late August of 2022.
Momentum trading is a strategy that aims to capitalize on the continuance of existing trends in the market. Momentum traders usually buy or sell an asset moving intensely in one direction and exiting when this movement shows signs of reversing. They also seek to avoid buying or selling assets that are moving sideways.
It is the risk that the overall market can decline, regardless of the performance of individual stocks. This is the most significant risk for any investment strategy, including momentum investing. For example, consider the COVID-19 crisis, which caused the overall market to crash for a short period.
Momentum trading carries with it a higher degree of volatility than most other strategies. Momentum trading attempts to capitalize on market volatility. If buys and sells are not timed correctly, they may result in significant losses.
The idea here is to identify a sector that exhibits strong momentum; this can be done by checking momentum in sector-specific indices. Once the sector is identified, look for the stocks that display maximum strength in terms of momentum. Momentum can also be applied on a portfolio basis.
Who is the father of momentum investing?
The philosophy of momentum investing encourages investors to invest more when prices are rising and sell them when they have peaked. The investing principle was made popular by Richard Driehaus, who is also known as the father of momentum investing.
The carry trade consists of borrowing low-interest-rate currencies and lending high- interest-rate currencies. The momentum strategy consists of going long (short) on currencies for which long positions have yielded positive (negative) returns in the recent past.
1 For trending analysis, momentum is a useful indicator of strength or weakness in the issue's price. History has shown that momentum is far more useful during rising markets than falling markets because markets rise more often than they fall. In other words, bull markets tend to last longer than bear markets.
Momentum investing involves making long-term investments in assets showing an upward trend. The rationale behind this strategy: an established trend is likely to continue. Thus, a momentum investor buys high and sells higher.
We find that the risk of momentum is highly variable over time and quite predictable. The major source of predictability does not come from systematic risk but from specific risk. Managing this time-varying risk virtually eliminates crashes and nearly doubles the Sharpe ratio of the momentum strategy.
Generally, you want to see up weeks in higher volume and down weeks in lower trade. Also look for churn, or heavy volume with little change in stock price. This type of action can signal a change in direction for stocks, either up or down. It tells you momentum is halting.
- Whenever you toss a ball at someone as well as it smacks him square in the face. It indicates how difficult it would have been to stop the thing.
- A baseball is swooping through the air.
- A large truck is moving.
- A bullet discharged from such a firearm.
Research has shown that intermediate term momentum between three and 12 months tends to work best. Relative strength, which is just a ranking of stocks from one to 99 (with 99 being the best) based on their past 12 month returns, is one way to measure momentum.
Momentum is generally used to mean increasing forward motion. A boulder rolling down a hill gains momentum. So does a great idea, a team on a winning streak, or the economy. To find an object's physical momentum you multiply its mass by its velocity.
Moving Average Convergence Divergence (MACD)
Often regarded as the best momentum indicator, MACD is a trend-following indicator. It represents the relationship between 2 moving averages of a financial instrument's price. MACD moves back and forth between moving averages and indicates momentum.
Can you make money from momentum trading?
The bottom line on momentum trading is that it is a higher-risk way to put money to work in the stock market. And it's certainly a form of trading, not investing. Momentum trading can be a good way to make money when things work out, but it can quickly result in big losses if things go the other way.
Compute returns - In your stock universe, find out the returns that your stocks have historically given. Then, you can rank stocks with the highest returns at the top. Create the momentum portfolio - Now pick the ten top stocks, the ones that show changes in returns, but good returns, nonetheless.
Money market funds are ultra low-risk mutual funds that invest in securities with short maturity periods, making them among the lowest-risk investments available outside of government bonds.
| Ticker | Company Name | Price |
|---|---|---|
| CVNA | CARVANA CO | $42.03 |
| IMGN | IMMUNOGEN, INC. | $29.50 |
| ACIC | AMERICAN COASTAL INSURANCE CORP | $11.62 |
| MLTX | MOONLAKE IMMUNOTHERAPEUTICS | $56.18 |
The Bottom Line
Safe assets such as U.S. Treasury securities, high-yield savings accounts, money market funds, and certain types of bonds and annuities offer a lower risk investment option for those prioritizing capital preservation and steady, albeit generally lower, returns.
