Momentum investing is a strategy that raises capital to continue a market trend. It focuses more on long stocks, futures, and market exchange-traded funds with upward trending prices while shorting assets with trending prices that go in a downward direction.
Momentum investing is very tight when implementing rules with technical indicators as the foundation. These indicators state some securities’ entry and exit points.
Statistically, only a few investment managers use this type of strategy because they would preferably depend on value indicators and fundamental factors.
Momentum investments cling to trends that give profit from the time they rise until they subside.
What is momentum in physics and finance?
In physics, momentum is the amount of motion that the object has. Momentum is an object in action or a mass in motion. The momentum amount depends on two things, namely: mass and velocity.
In finance and investment, momentum can either be the security’s price or volume’s acceleration. In layman’s terms, momentum is how fast the price changes. Technically, momentum helps identify market trends.
Momentum investing in operation some example scenarios
As we have mentioned earlier, momentum investing follows strict rules that technical indicators dictate. These indicators state some securities’ entry and exit points.
Let’s say a momentum investor uses two longer-term moving averages. The other one will be shorter for trading signals.
For example, a momentum investor can use a 60-day and a 300-day moving average. If the 60-day moving average is above the 300-day average, then it is a buy signal.
On the other hand, if the 60-day moving average is below the 300-day moving average, it is a sell signal. It is now evident why only a few traders use even longer-term moving averages when they want to show signaling.
Variations of the momentum investing strategy
Another momentum investing strategy has a price-based signal. The sector goes long exchange-traded fund with the highest momentum impact and then goes short on the exchange-traded fund sector with the lowest momentum impact.
Later on, a rotation in and out of the sectors happens accordingly.
Other momentum investing strategies still consider cross-asset analysis, where equity traders are always on the lookout for the treasury yield curve.
Why? This yield curve will serve as a momentum signal of equity entry and exit. For example, if a 15-year treasury yield is above a 6-year yield, it is a buy signal, while a 6-year yield above a 15-year yield is a sell signal.
The treasury yield years can somehow tell recessions and give stock market impacts.
Should an investor consider momentum investments?
Unlike most investment managers, few use the strategy of momentum investing. They have faith in individual stock picking with discounted cash flow analysis and several fundamental factor bases.
They believe that this strategy is a more convenient way to beat index long-term performance and produce expected results.
In conclusion, if you consider momentum investing, be specific about the securities that will work for you. Know and understand their liquidity and how big the trading volume is.