Does momentum investing still work?
Concluding Thoughts: Momentum investing remains a significant force in the stock market. Our paper offers insights into navigating its complexities, balancing risk and reward, and optimizing investment strategies.
The empirical research demonstrates that, on average, investing in previous winners and short-selling previous losers has offered significant returns that cannot be explained by other common risk factors. But momentum also displayed huge tail risk, as there were short but persistent periods of highly negative returns.
This approach can yield substantial returns, particularly during bullish market conditions when trends are robust and enduring. Momentum investors hold the belief that once a trend, whether upward or downward, takes shape, it is likely to persist for a certain period.
The bottom line on momentum trading is that it is a higher-risk way to put money to work in the stock market. And it's certainly a form of trading, not investing. Momentum trading can be a good way to make money when things work out, but it can quickly result in big losses if things go the other way.
The success of momentum can be explained by a variety of behavioral, market friction, and risk considerations. Under certain conditions, momentum will tend to not work, including post-decimalization, after bear markets, during periods of volatility, and when value stocks outperform.
– a balanced way to excess return
The value investor traditionally has a long-term focus with respect to analysis and return expectations. On the contrary, momentum investors focus more on short-term news flows and stock movements. Often the two strategies do not work at the same time14.
Momentum traders will seek to identify how strong the trend is in a given direction, then open a position to take advantage of the expected price change and close the position when the trend starts to lose its strength.
Ticker | Company Name | Price |
---|---|---|
CVNA | CARVANA CO | $69.16 |
SMCI | SUPER MICRO COMPUTER INC | $960.08 |
APLT | APPLIED THERAPEUTICS INC | $4.83 |
VERA | VERA THERAPEUTICS INC | $40.01 |
The investing principle was made popular by Richard Driehaus, who is also known as the father of momentum investing. Investment advisors and experts often point out that investors should buy undervalued stocks and sell them later at high prices to earn gains.
Edit Title. Momentum Trap stocks are those with low durability scores, expensive valuation, but high momentum. These stocks are risky bets that investors may be drawn to due to changes in share price. They however do not necessarily justify existing valuations and share price gains.
What are the disadvantages of momentum investing?
Limitations of Momentum Investing
Needs Constant Research: This investment strategy is highly time-intensive; you need to keep track of the price of a specific stock or a basket of stocks on a daily basis to choose a suitable investment plans and reduce the risk of potential losses.
Indicator-Based Directional Trading
This strategy uses an indicator to determine the direction of the trade. The indicator provides a clear signal when it's time to enter or exit a trade, making it easy to work with. Traders who use this strategy can expect to see consistent results and high success rates.
Momentum investing involves making long-term investments in assets showing an upward trend. The rationale behind this strategy: an established trend is likely to continue.
Potential for High Profits Over a Short Period
You then sell at a profit of 50% before the stock price corrects itself. You've made a 50% return over the course of a few weeks or months (not an annualized return). Over time, the profit potential increase using momentum investing can be staggeringly large.
Select a Time Frame: Decide on a specific time frame for momentum ranking, such as the past 6 or 12 months. This determines how far back you'll look to assess stock performance. Calculate Average Returns: For each stock, calculate the average daily return over your chosen time frame.
The momentum strategy consists in buying the past J months winners and selling the past J months losers, and to hold this position during the K next months. ...
Principle 1: Low Price to Earnings
Stocks with low price/earnings ratios historically have outperformed the overall market and provided investors with less downside risk than other equity investment strategies.
Generally speaking, in developed countries, many studies have confirmed the existence of momentum strategy and found contrarian strategy to be more efficient during long-term period.
A store of value is an asset that maintains its value, rather than depreciating. Gold and other precious metals are good stores of value because their shelf lives are essentially perpetual.
The 11 am rule suggests that if a market makes a new intraday high for the day between 11:15 am and 11:30 am EST, then it's said to be very likely that the market will end the day near its high.
Are momentum stocks risky?
Just like any other trading style, there are risks that come with momentum trading. By using this technique, you should know that you are trading on the backs of other people in the market, and price trends are never guaranteed. And always be prepared for unexpected reversals or corrections that take place.
- Simple Moving Average (SMA) ...
- Support and Resistance Levels. ...
- Trendline Trading. ...
- Flags and Pennants. ...
- Exponential Moving Average (EMA) ...
- Closing Price Breakouts. ...
- Ichimoku Cloud. ...
- Average Directional Movement Index (ADX)
- Cisco Systems Inc. (ticker: CSCO)
- Comcast Corp. (CMCSA)
- Telus Corp. (TU)
- Unilever PLC (UL)
- Sony Group Corp. (SONY)
- Toronto-Dominion Bank (TD)
- Solventum Corp. (SOLV)
- Essential Utilities Inc. (WTRG)
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.
Company (ticker) | Analysts' consensus recommendation score | Analysts' consensus recommendation |
---|---|---|
Amazon.com (AMZN) | 1.30 | Strong Buy |
Microsoft (MSFT) | 1.32 | Strong Buy |
Delta Air Lines (DAL) | 1.35 | Strong Buy |
Nvidia (NVDA) | 1.38 | Strong Buy |