Momentum Investment Meaning Formula Controversy
Momentum Investment: Meaning, Formula, Controversy
What Is Momentum Investing?
Momentum investing is a strategy that capitalizes on existing market trends. Investors buy rising securities and sell them at their peak.
Momentum, in markets, refers to the ability of a price trend to sustain itself.
Key Takeaways
– Momentum investing aims to capitalize on existing market trends.
– Market momentum refers to the ability of a price trend to sustain itself.
– Momentum investing involves strict rules based on technical indicators.
– Few professional investment managers use momentum investing.
Understanding Momentum Investing
Momentum investing involves going long on upward-trending stocks, futures, ETFs, or any financial instrument and shorting assets with downward-trending prices.
Momentum investors believe trends can persist and profit by staying with them. For example, investors who entered the U.S. stock market in 2009 enjoyed an uptrend until December 2018.
Fund manager Richard Driehaus is credited with popularizing momentum investing.
Momentum Investing Methods
Momentum investing relies on technical indicators to determine entry and exit points for securities.
Some investors use two moving averages (MAs) for trading signals. The 50-day crossing above the 200-day creates a buy signal, while a crossing back below creates a sell signal.
Another strategy involves following price-based signals to buy sector ETFs with strong momentum and short those with weak momentum.
Cross-asset analysis is also used, such as watching the Treasury yield curve for equity signals.
Some strategies combine momentum factors with fundamental factors, like CAN SLIM, which seeks stocks with earnings and sales momentum.
When practicing momentum investing, choose securities with liquidity and consider trading volume.
The Debate Over Momentum Investing
Few professional investment managers use momentum investing. They believe fundamental analysis produces more predictable results.
However, momentum investing has its advocates. A study found that buying recent stock winners and selling losers generated higher returns than the overall U.S. market.
Technical Indicators for Momentum Traders
Technical analysts use various momentum indicators, such as RSI, ROC, stochastics, and MACD.
Formula for Market Momentum
Market momentum can be defined as M = V – Vx, where V is the latest price and Vx is the closing price x number of days ago.
Market Psychology Behind Momentum Trading
Momentum traders benefit from herd mentality, greed, and fear of missing out. This can cause bull markets to rise higher and selloffs to become crashes.
