Investment advisors and experts often point out that investors should buy undervalued stocks and sell them later at high prices to earn gains. It is also not considered prudent to buy when the stocks are rising into over-priced territory, or to sell in panic.
They are told to stay away from irrational exuberance as well as from widespread panic.
Momentum investing, on the other hand, follows a different strategy and encourages investors to invest in stocks when they are rising, and sell them when they have already peaked or started to fall.
Here we explain the concept in detail.
What is momentum investing?
This is a principle of investing in which investors are encouraged to ride the market wave instead of making contrarian bets. Under this, investors invest in the stocks when they are on a rise, and sell them when they are on a decline.
The rational behind this is the assumption that the market would, at least for the time being, follow the current trajectory and not reverse the trend.
The investing principle was made popular by Richard Driehaus, who is also known as the father of momentum investing. According to him, one can make far more money by buying high and selling at even higher prices instead of looking for undervalued securities.
Key points to remember:
1. The principle entails buying a rising stock and selling it even higher when it has peaked or started to fall.
2. The rationale behind the principle is that in the short term, market trajectory remains constant, and a rising stock will rise for some more time, and the falling stock would continue the fall.
3. The principle was made popular by Richard Driehaus who asserted that instead of looking for undervalued stocks, an investor should focus on buying high and selling even higher.
4. The strategy is applicable in the short term and requires regular monitoring of stock prices.
Let us understand this with the help of an illustration.
Suppose Mr X has ₹5,000 to invest in company ‘A’ whose shares are rising. Let us suppose, the shares of ‘A’ are trading at ₹100 and have already risen 10 percent in the past one month. So, X can now buy 50 shares for ₹100 each and earn gains later as these shares are on an upward trajectory.
He can, later, sell them when the prices have peaked at ₹120 or start to fall afterwards.
After two months, let us suppose the shares start falling after touching ₹120 and the price within one week has already hit ₹115; then as per the momentum investing, X should sell his 50 shares for ₹5,750 (115 X 50).
In the above illustration, X carried out two transactions: one to buy shares when they were rising and second to sell them during their fall. At the end of these two transactions, he was richer by ₹750 (5,750-5,000).
All he had to do was buy a rising stock and sell a falling one.
Approach: Value investors a contrarian approach, looking for stocks trading below their intrinsic value due to market pessimism or temporary setbacks. But a momentum investor
momentum investor
Momentum investing is a system of buying stocks or other securities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period.
https://en.wikipedia.org › wiki › Momentum_investing
Potential for high returns: If an investor correctly identifies and rides trends, momentum investing can lead to significant profits for that investor. Securities that have performed well tend to continue their trajectory. This way, prospects for above-average gains are secured.
In essence, momentum strategies perform when prices continue in the same direction while the value approach delivers when prices move in the opposite direction. For that reason, the approach to combine the two strategies helps to manage risk.
Opting to invest in momentum funds can present a lucrative opportunity for investors seeking substantial returns. For instance, the Nifty 500 Momentum 50 Index monitors the progress of 50 specific stocks meticulously chosen through normalized momentum scores derived from the Nifty 500 index.
Momentum investing is a strategy designed to profit from the persistence of prevailing trends in the market. This investing strategy involves prioritising the purchase of assets experiencing upward momentum and selling them when indications suggest a weakening trend.
Value investing is an evergreen strategy that requires patience in the long term. However, momentum investing can give you handsome returns in the short to medium time horizon following price action moves along an improving financial performance of the company.
A price-based momentum portfolio consists of stocks that have exhibited the highest momentum over the desired time frame. Price-based momentum works best in an upward trending market and not in a sideways or a down trending market.
A value investor seeks out above-average companies and invests in them. Therefore, the probable range of return for value investing is much higher. In other words, if you want the average performance of the market, you're better off buying an index fund right now and piling money into it over time.
Although momentum is a short-term phenomenon, it is best suited for long-term investors. It won't always work, but there's a good chance that a disciplined momentum strategy will continue to outperform over the long term.
The Moving Average Convergence Divergence (MACD) is one of the most popular momentum indicators. The MACD uses two indicators – moving averages – turning them into an oscillator by taking the longer average out of the shorter average.
Momentum investing offers the potential for high profits over a short period by capitalizing on market volatility. Investors buy stocks that are trending upward and sell them before prices decline, aiming for substantial returns quickly.
Treasurys, says Collins, are similar to government and corporate bonds, as they are backed by the full faith and credit of the U.S. government. They are typically seen as safe investments during a recession.
Greatest Momentum Investor #1: Richard Driehaus. Richard Driehaus, an American investor, is widely known as the father of momentum investing. He founded Driehaus Capital Management in Chicago, focusing on growth and momentum strategies.
Time frame: Momentum has to be calculated over a time frame – for instance, a few days or a few months. Price indicator: Price indicators are formulae that use past prices and trading volumes of stocks to help predict where their prices might go next.
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 offers the potential for high profits over a short period by capitalizing on market volatility. Investors buy stocks that are trending upward and sell them before prices decline, aiming for substantial returns quickly.
While momentum investing may not be suitable for everyone, it offers several advantages that can be particularly beneficial during bear markets. 1. Potential for Outperformance: Momentum funds have the potential to outperform other investment strategies during bear markets.
Momentum measures the rate of the rise or fall in stock prices. 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.
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