Understanding Momentum Investing

Momentum investing involves identifying and capitalizing on trends in the market. It works on a strategy that involves buying securities with recent upward price trends and with the potential to scale up further. It is often summarised as a ‘buy high, sell higher’ approach. Learn in detail about momentum investing as we explore the topic.

Definition & Core Idea

Momentum investing strategy focuses on buying assets with strong performance in the market while selling the assets with weak performance. It is applicable to the trends over a recent period. This concept focuses on ‘buy high, sell higher’ rather than ‘buy low, sell high’.

Additionally, the investors also use the approach to ‘ride the wave’. It is because they tend to persist in the short to medium term, and the investors profit by riding the momentum before it reverses.

How Momentum Investing Works?

Momentum investing generally involves short-term investing. It acts in the following stepwise format:

• Identify trends: Find the assets with steadily increasing or decreasing prices.

• Ride the wave: Buy the strong-performing assets expecting continued growth. Simultaneously, sell weak performing assets, anticipating further decline.

• Use technical analysis: Apply tools like Relative Strength Index (RSI), trend lines, moving averages and price rate of change to confirm momentum signals.

• Plan the Exit: Exit positions before momentum fades or reverses, aiming to lock in gains at or near the peak.

Strategies in Momentum Investing

Having understood ‘what is momentum strategy’, now understand the associated strategies. There are different strategies in momentum investing discussed as follows:

• Check the highs: Track assets consistently reaching new highs as these often signal strong upward momentum.

• Look for volatility: Monitor the assets with significant price swings since higher volatility can provide stronger momentum opportunities.

• Identify price trends: Use technical indicators to detect and confirm trends.

• Identify the strong sectors: It involves recognition of the sectors showing consistent performance and focus on trading within them for higher success rates.

• Consider the risks: Momentum investing also involves certain risks due to sudden reversals.

• Stay disciplined: Avoid emotional investing and be aware that momentum may fade. Hence, a thoughtful approach is essential.

Benefits & Risks Associated with Momentum Investing

The advantages to expect from momentum investing include:

• Capitalises on investor behaviour: Strong performing stocks attract more investors, which creates a feedback loop that drives prices further upward.

• Performs well in rising markets: Rising stock prices and momentum during market upswings can accelerate returns.

• Broader opportunities: Not limited to specific sectors, momentum strategies allow investors to explore a wide range of stocks and markets.

• Portfolio diversification: Investors can spread their investments across various high-performing trends while still focusing on momentum.

The risks associated with momentum investing include:

• Requires constant monitoring: Investors must track trends closely and make quick decisions that can be challenging if someone lacks expertise.

• Higher transaction costs: Frequent buying and selling can lead to increased fees, thus reducing net profits.

• Vulnerability to reversals: Unexpected trend changes can result in losses if not managed carefully.

• Dependence on market conditions: Momentum strategies thrive in rising or expected to rise markets but may underperform during downtimes.

Momentum Investing vs Value/Index Investing

Momentum investing differs from value or index investing in certain parameters. Here are the insights into the same:

Is Momentum Investing Suitable for You?

Momentum investing is a suitable option if you are an investor who can handle short-term volatility, has a risk appetite, and is active and disciplined. It requires the investors to understand market behaviours. It is because the investment is influenced by factors like regulatory shifts, volatility and macroeconomic developments. Momentum investing can complement a long-term value strategy for a balanced portfolio. The option is a better choice for individuals who prefer faster potential gains and have high risk tolerance.

Disclaimer: Past performance may or may not be sustained in the future.

Conclusion

Momentum investing offers opportunities to profit from rising market trends and investor behaviour. But it comes with a higher risk and requires active management. It suits investors who can handle short-term volatility, make quick decisions and stay disciplined. The momentum investing can be better utilised by understanding one’s risk tolerance, market conditions and investment goals.

Disclaimers:

The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.