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Business News/ Money / Personal Finance/  Momentum investing: What is it and is this strategy better than value investing? An explainer
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Momentum investing: What is it and is this strategy better than value investing? An explainer

The philosophy of momentum investing encourages investors to invest more when prices are rising and sell them when they have peaked.

The investing principle was made popular by Richard Driehaus, who is also known as the father of momentum investing.Premium
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. It is also not considered prudent to buy when the stocks are rising into over-priced territory, or to sell in panic. 

They are told to stay away from irrational exuberance as well as from widespread panic.  

Momentum investing, on the other hand, follows a different strategy and encourages investors to invest in stocks when they are rising, and sell them when they have already peaked or started to fall.

Here we explain the concept in detail. 

What is momentum investing?

This is a principle of investing in which investors are encouraged to ride the market wave instead of making contrarian bets. Under this, investors invest in the stocks when they are on a rise, and sell them when they are on a decline. 

The rational behind this is the assumption that the market would, at least for the time being, follow the current trajectory and not reverse the trend.

The investing principle was made popular by Richard Driehaus, who is also known as the father of momentum investing. According to him, one can make far more money by buying high and selling at even higher prices instead of looking for undervalued securities.

Key points to remember:

1. The principle entails buying a rising stock and selling it even higher when it has peaked or started to fall.

2. The rationale behind the principle is that in the short term, market trajectory remains constant, and a rising stock will rise for some more time, and the falling stock would continue the fall. 

3.  The principle was made popular by Richard Driehaus who asserted that instead of looking for undervalued stocks, an investor should focus on buying high and selling even higher.

4. The strategy is applicable in the short term and requires regular monitoring of stock prices. 

Let us understand this with the help of an illustration. 

Suppose Mr X has 5,000 to invest in company ‘A’ whose shares are rising. Let us suppose, the shares of ‘A’ are trading at 100 and have already risen 10 percent in the past one month. So, X can now buy 50 shares for 100 each and earn gains later as these shares are on an upward trajectory. 

He can, later, sell them when the prices have peaked at 120 or start to fall afterwards.

After two months, let us suppose the shares start falling after touching 120 and the price within one week has already hit 115; then as per the momentum investing, X should sell his 50 shares for 5,750 (115 X 50).

In the above illustration, X carried out two transactions: one to buy shares when they were rising and second to sell them during their fall. At the end of these two transactions, he was richer by 750 (5,750-5,000).

All he had to do was buy a rising stock and sell a falling one.

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Published: 22 Jan 2024, 11:28 AM IST
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