Understanding Momentum Investing in the Share Market

Momentum investing is a popular strategy that leverages prevailing market trends. It involves buying stocks that exhibit upward momentum and selling those that show signs of weakening. This approach is based on the idea that stocks that have been rising will continue to rise, as it takes an external force (like negative news) to break them.

Basics of Momentum Investing

Like Newton’s first law of motion, momentum investing posits that a stock or asset will continue its current direction until an external factor (such as a significant news event or broad market downturn) intervenes. Momentum investors buy stocks that are on the rise and sell those that are declining, following the trends until there is a clear reversal.

Main Momentum Investment Strategies

Momentum investing primarily revolves around two main strategies:

Absolute or Time-Series Momentum

This strategy involves analyzing the past performance of a stock over a specific time period, such as 3, 6, 9, and 12 months. By identifying stocks that have consistently performed well over these time frames, investors aim to capitalize on their continued upward momentum.

Relative Cross-Sectional or Dual Momentum

This strategy compares the relative performance of a stock to others in the same sector or to market indices. For example, if Stock A has rallied 15% compared to Stock B which has rallied 10% over the same period, Stock A would be considered to have higher relative momentum.

Advantages and Disadvantages of Momentum Investing

While momentum investing can be highly profitable, it also comes with its own set of challenges:

Pros: It allows investors to capitalize on strong trends quickly. Cons: Good performance in the past does not guarantee future success. Some high-performing momentum stocks can reach valuations that are considered risky.

Conclusion and Future Research

Like any investment strategy, momentum investing can be successful if one can accurately identify and ride the trends. However, proper risk management and portfolio diversification are crucial to minimize potential losses. In the coming months, I will be conducting further research on momentum strategies using open-source tools like Python. You can follow my progress on my space called Science Based Investing.