Momentum Investing Definition

What Is Momentum Investing?

Momentum investing is a technique that goals to capitalize on the continuance of an current market development.

Understanding Momentum Investing

Momentum investing entails going lengthy on shares, futures, market exchange-traded funds (ETFs), or any monetary instrument exhibiting upward-trending costs and quick the respective belongings with downward-trending costs.

Momentum investing holds that tendencies can persist for a while and that it’s potential to revenue by staying with a development till its conclusion, regardless of how lengthy that could be. For instance, momentum traders that entered the U.S. inventory market in 2009 typically loved an uptrend till December 2018.

Momentum Investing Strategies

Momentum investing normally entails abiding by a strict algorithm based mostly on technical indicators that dictate market entry and exit factors for explicit securities.

Momentum traders generally use two longer-term shifting averages (MAs), one a bit shorter than the opposite, for buying and selling alerts. Some use 50-day and 200-day MAs, for instance. On this case, the 50-day crossing above the 200-day creates a purchase sign, whereas a 50-day crossing again under the 200-day creates a promote sign. A couple of momentum traders choose to make use of even longer-term MAs for signaling functions.

One other kind of momentum investing technique entails following price-based alerts to go lengthy onsector ETFs with the strongest momentum, whereas shorting the sector ETFs with the weakest momentum, then rotating out and in of the sectors accordingly.

Different momentum methods contain cross-asset evaluation. For instance, some fairness merchants intently watch the Treasury yield curve and use it as a momentum sign for fairness entries and exits. A ten-year Treasury yield above the two-year yield typically is a purchase sign, whereas a two-year yield buying and selling above the 10-year yield is a promote sign. Notably, the two-year versus 10-year Treasury yields are typically a powerful predictor of recessions, and likewise has implications for inventory markets.

As well as, some methods contain each momentum components and a few elementary components. One such system is CAN SLIM, made well-known by William O’Neill, founding father of Investor’s Enterprise Each day. Because it emphasizes quarterly and annual earnings per share (EPS), some might argue it’s not a momentum technique, per se. Nevertheless, the system typically seeks shares with each earnings and gross sales momentum and tends to level to shares with worth momentum, as properly.

Like different momentum programs, CAN SLIM additionally consists of guidelines for when to enter and exit shares, based mostly primarily on technical evaluation.

The Debate Over Momentum Investing

Few skilled funding managers make use of momentum investing, believing that particular person inventory choosing based mostly on an evaluation of discounted money flows (DCFs) and different elementary components have a tendency to provide extra predictable outcomes, and is a greater technique of beating index efficiency over the long run. “As an funding technique, it’s a thumb within the eye of the environment friendly market speculation (EMH), one of many central tenets of contemporary finance,” to cite a UCLA Anderson Evaluate article, “Momentum Investing: It Works, However Why?”

Nevertheless, momentum investing has its advocates. A 1993 examine revealed within the Journal of Finance documented how methods of shopping for latest inventory winners and promoting latest losers generated considerably increased near-term returns than the U.S. market general from 1965 to 1989.

Extra not too long ago, the American Affiliation of Particular person Buyers (AAII) discovered that, in October 2017, CAN SLIM beat the S&P 500 within the trailing five-year and 10-year intervals, and has crushed it soundly over a fair longer timeframe.