Is momentum investing a viable strategy?

Is momentum investing a viable strategy?

Last Updated: 2019-01-11T04:30:00+05:30

For most of us our liaison with equity markets begins with an online share trading account. Even as you decide whether you want to buy and sell equities for the short term or long term, there is a bigger fundamental question pertaining to your approach. Should you focus on direction or on momentum? For online trading, momentum is something understood fairly intuitively. Momentum is generally considered most relevant to traders who always need to remain on the right side of the momentum. But does this momentum approach apply to investing too?

5 things you must know about momentum investing

Let us quickly look at what is momentum in online trading and what does momentum investing entail. Here are 5 key takeaways.

  • Momentum is the trend of the stock for the short term. This can vary from 3 months to one year and is normally a sub-cycle within the broader direction.

  • Momentum is illustrated by technical support and resistance levels as well as news flows, both domestic and international.

  • Momentum investing is nuanced. When momentum is positive but weak, the strategy is to buy on dips. When upside momentum on is strong, even leverage is OK.

  • Momentum is measured using indicators like oscillators, stochastic, MACD, parabolic and many others. They can understand and also predict the momentum.

  • Traders and investors need to understand momentum before direction to avoid being caught on the wrong foot. That is the key to online share trading.

How investors can apply momentum for investing

The normal narrative is that trading is for the short term and investing is for the long term. But the long term is nothing but an aggregation of short term units and to thrive in the long term, online trading must survive the short to medium term. Here is how momentum helps!

  • If you see price movement of a stock, bulk of the returns come in a short span of time. That is what momentum can help you catch and reduce your cost of holding the stock. There are lucrative profits to be made from momentum investing. Take the case of Bajaj Finance when it corrected in late 2018. The overall NBFC sentiments were weak but momentum investing would have helped you spot Bajaj Finance as the pick of the pack. You would have actually been 60% richer in less than a year.

  • Momentum makes volatility work to your advantage. It is said that volatility separates the men from the boys or the wheat from the chaff. Momentum investors look for stocks to invest in that are on their way up and then sell them before the prices start to go back down. Here momentum investing can help to maximize ROI.

  • You can be an emotional contrarian with momentum investing. In other words, you can use momentum investing to leverage the emotional decisions of others. While most traders and investors tend to be emotional there is merit in making the best of the disruptions they cause. Momentum investing is more organized and systematic and that can make your online share trading get the better of the market.

Momentum investing is smart, but it has a cost too

Momentum investing does appear to be quite smart on paper. You adopt a rule-based approach and outsmart the market. But that is easier said than done. Here are a few challenges you will be up against in momentum investing.

  • Timing the momentum is a dirty game. A few wrong calls and a lot of good work can get wiped out. Keep your risk levels in check while indulging in momentum investing! In fact, momentum investors accept this risk as payment for the possibility of higher returns.

  • Momentum has higher costs in terms of transaction costs, statutory costs, tax implications and opportunity costs. You need to add these up before jumping in to any momentum investing decision. It also is a process that is time-intensive and requires a lot of effort and involvement from your side. You have to make it worth the while.

  • There is an anomaly in momentum investing that it naturally works best in a bull market. That is when because investors tend to display their herd mentality and momentum investors can profit from the same. Bearish markets are either violent or lacklustre. Your opportunities will largely shrink.

Should you jump into momentum investing?

There are no clear and obvious answers and will depend on your level of involvement and expertise. Momentum investing can work, but it may not exactly be practical for all types of investors. One thing you need to remember that if you are a retail investor, you don’t have the unfettered access to news and flows that institutional investors have. So, you will be trying to do momentum investing based on second hand news and that is unlikely to work. In such cases, a more passive approach or a long term approach to buying and holding quality stocks may work better. But you can always try your hand at momentum investing with limited risk. It is just that you need to be disciplined.

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