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Business News/ Money / Personal Finance/  What is Momentum Investing and How can I use it to trade efficiently?
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What is Momentum Investing and How can I use it to trade efficiently?

Investors utilise momentum to trade stocks, with optimistic momentum indicating a rising price and negative momentum indicating a dropping price. Read the article to learn about the advantages, disadvantages, and many forms of momentum investing.

We explain here what is Momentum Investing and How can I use it to trade efficiently (Image by Gerd Altmann from Pixabay)Premium
We explain here what is Momentum Investing and How can I use it to trade efficiently (Image by Gerd Altmann from Pixabay)

Momentum investing is a type of investment technique that involves buying stocks that have been trending upward or short-selling stocks that have been trending lower. The basic argument for momentum investing is that once a trend has been formed, it is more likely to persist.

This isn't a brand-new investing technique. This strategy's mechanics are built on the financial concept of reducing your losses and riding your gains. To put it another way, momentum investing expects that short-term success is duplicated, with winners being winners and losers remaining losers.

How does Momentum Investing work?

Because traders are only seeking to catch a portion of a trend's price fluctuations, momentum investing is often short-term and is carried out in a methodical manner. To determine the existence of a trend, a trader employs technical indicators like trend lines and moving averages.

The trader takes a trading position in the direction of the trend as it develops momentum and strengthens. He looks to buy during an uptrend and favours selling during a downtrend. Prior to any real trend reversal, the trader attempts to exit their position (preferably at a profit) when the trend's momentum shows symptoms of fading, such as a disparity between price movements and the motion of momentum indicators.

What are the types of Momentum Investing?

There are two types of momentum investing- Absolute Momentum Investing and Cross-sectional Momentum investing.

Absolute Momentum Investing

An asset's performance is compared to its own past performance under absolute momentum and momentum may be discovered by setting a profit percentage as a criterion, and then buying the shares or assets that have exceeded the benchmark. For example, rating stocks based on their own 12-month performance would yield a list of the best-performing stocks.

Cross- sectional Momentum Investing

In cross-sectional momentum, the performance of the asset in question is compared to that of other similar asset classes. For example, gold rose 15% over the course of a year, while share prices rose just 12%. As a result, gold has a stronger relative velocity than stocks.

What are the advantages of Momentum Investing?

High Profits Over a Short Period of Time 

If you buy a stock for Rs. 1000 and it increases to Rs. 1500, you have made a profit. Then, before the stock price changes, you decide to sell it again at a profit margin of 50%; you made a 50% profit in a couple of months. Using momentum, the potential for profit will grow with time.

Volatile Market

The goal of momentum investing is to profit from turbulent market developments. It all comes down to finding high-priced equities and selling them before they fall in value.

Taking Advantage of Other Investors' Emotional Decisions

There is a structured strategy used by momentum investors, which comprises a defined purchasing and selling point. Rather than being governed by emotional responses to stock prices, as many investors are, they attempt to profit from the price movements created by emotional traders.

What are the disadvantages of Momentum Investing?

Time-Intensive: Momentum investors must also maintain track of market facts on a frequent basis, since the price might fluctuate significantly many times each day, necessitating a daily update, even if not hourly. This involves staying up to current on any unfavourable news that can trouble investors.

High Costs: Due to the large costs involved, momentum investing can be expensive. The problem of exorbitant fees is being addressed by low-cost dealers, but it remains a big worry.

Sensitive to the market: In a bull market, momentum investing is seen to perform best since investors are more likely to herd. Greater market precaution reduces the profit margin on momentum investing in a bear market.

What are the technical indicators of Momentum Investing?

Trend Lines

A basic technical analysis technique for tracking price fluctuations is trend lines. On a price chart, a trend line is drawn connecting two consecutive points. If the resultant line slopes higher, it suggests a favourable, bullish trend, and an investor might consider buying shares. If the resultant line is downward sloping, the trend is unfavourable or bearish, then selling short is the most likely lucrative strategy.

Moving Averages

Traders can use a moving average line to detect the current trend while removing most of the "noise" in the market that arises from minor, unimportant price swings. An uptrend exists when the price of a security continuously stays at or above its moving average and a downtrend is often shown by price staying at or below a specified moving average.

Stochastic oscillator

The stochastic oscillator compares the most recent closing price of an asset to the prices over a given time period. The trend is favourable when the closing price for the period is towards the peak of the price range. A declining trend is shown when the closing price is near the low.

Momentum investing has had a dream run in India during the last few years and with the Indian economy gaining strength and economists anticipating a cyclical rebound, momentum investing should be the mainstream investing type in the next several years.

 

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Published: 03 Mar 2022, 09:38 AM IST
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