Have you heard of momentum investing?
When it comes to stock investment, you’ll find no shortage of advice. Value investing is often first pitched to beginner investors, and it seems to make a lot of sense.
But here is the thing, value investing requires us to buy and hold a stock for a very long time horizon. And that does not work well with our human brain.
On the other hand, you probably find little discussion about “momentum investing”, but that is where the big money is made. Momentum investing is a simple concept which many big financial institutions use for their own investments for decades.
Instead of trying to counter our investing behavioral flaws, momentum investing takes advantage of our herding behavior. This article will explain the basic concepts of momentum investing.
What is Momentum Investing
With any investment strategy that has worked historically, there are usually two reasons
- The strategy takes more risks and you are compensated for those risks
- The strategy coincides with investors’ behaviors which puts you on the right side of the market
In a nutshell, momentum investing comes from the idea of trying to take advantage of existing trends in a stock price. It jumps into a movement rather than buying a stock when it is in a downtrend or stagnant.
- If the stock market is going up, you will buy in and wait for it to continue going up;
- If the market is going down, you may take up a short position in anticipation that it will continue to go down or you may just hold cash completely
Let the profits run
Think about when was the last time you sold a winning stock? How much did you make? 10%? 20%? Did the stock go up another 100% after you sold it?
I first learned about momentum investing from Gary Antonacci’s book “Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk“.
The idea of momentum investing is that once you’re on board with a strong trend, you should stay on board as long as that trend keeps up. It is tempting to pull out when you start to make money, but that is an amateur’s mistake. Legendary trader Jesse Livermore said,
Big money is not in the individual fluctuations, but in sizing up the entire market and its trend… Prices are never too high to begin buying or too low to begin selling.
Letting profits run is one of the top 5 traits of successful traders. You need not be a trader yourself but you should understand that is how money is made.
Cut losses as needed
The other side of momentum trading is to cut losses, which essentially means letting go of an investment as soon as it becomes clear it’s not working out.
Human nature is often to hold on and withstand early losses in the hopes of a turnaround. But there is no one-way train and any momentum will stop at some point in time.
When a trend reverses, it is most likely to continue for some time. Practically, you won’t be able to get out at the exact turning point, but it is better to leave the battlefield when you’re only a little bit down instead of exposing yourself to be completed wounded.
Have a rule-based system
Momentum investing not a new strategy, and it has served the institutions well for decades. Therefore, there are already many fairly established systems and mathematics in place to identify the trends.
That is good news for retail investors like us because you can leverage on those research if you know how.
Since I practice what I pitch and I have helped many investors (my clients) to adopt this strategy in the real world. I would like to offer a word of caution.
All the secrets of success have been discovered, what is left is how to apply for it. – Ivan Guan
Momentum investing is not a secret. Just like any other investment strategies, it is difficult to practice at the beginning.
Even if you consider yourself financially literate or having some investment experiences, you should be patient and open-minded about how the result may turn out.
Momentum investing is not about predicting the future, but to use the available information now.
It is about identifying strong upward or downward movement that already exists in the stock market. You then look to capitalize, letting your profits run and cutting your losses as needed.
You can subscribe my weekly financial tips for more information about this strategy. And if you have any question, leave your comments below and I will answer all of them.
Interesting article. Bigger risks comes with bigger rewards. However, good money management can help limit that risks!