Everyone says “buy low, sell high” for seemingly obvious reasons. But what if you found out some investors were applying a slight variation of that advice…and often seeing great returns doing it?
These investors exist, and they follow a strategy called momentum investing.
Momentum investing involves making long-term investments in assets showing an upward trend. The rationale behind this strategy: an established trend is likely to continue. Thus, a momentum investor buys high and sells higher.
But momentum investing isn’t just a “hey, this stock looks like it’s doing well, I’ll throw my money at it” strategy. Below, we’ll explore why a momentum investing strategy could work when you do it right.
Momentum means do more of what’s working–it represents the capital flow
If an asset is on the rise, there can be some sense in jumping in on that trend. Those trends, after all, represent the flow of capital. Instead of trying to fight that flow, you might potentially be better off joining it—assuming you do the proper analysis and have specific rules set in your Model to guide you in entering and exiting the investment at an appropriate time.
These buy and sell disciplines are meant to eliminate human error and biases often caused by trying to time the market. A disciplined approach does not mean flawless, it means probabilistic–not all trades/signals work but over time, they can add value.
Momentum allows exposure to secular trends
A “secular” trend or market is one that is likely to continue over a long period of time. Momentum investing’s bread and butter is profiting off trends, making it perfect for taking advantage of, well, secular trends.
The various sub-sectors of the tech industry is a good example. Certain technologies across sectors, such as autonomous vehicles, aren’t likely to slow down anytime soon. Yes, there may be short-term corrections, but successful momentum investors should have the proper rules set in their Model that allow them to ride out the short-term corrections without worry.
Either way, we aren’t regressing technologically and momentum investing strategies can get you in on these trends.
Momentum investing can help investors avoid “catching falling knives”
Trying to time a market drop to buy in at the lowest point can be dangerous, just like trying to catch a falling knife. You might get in right at the bottom—or you might miscalculate and ride the position down much further.
A momentum investor might see a downtrend and decide to hold cash and wait for positive momentum to reassert itself. While this may lead to some opportunity cost, it can allow an investor to minimize larger drawdowns as there are some periods where negative momentum can last for a long time (think 2007/2008).
Momentum investing is not foolproof, but it helps investors get exposure to themes inside of an index
Nothing is foolproof—especially momentum investing, which can be tough to get right.
However, momentum investing helps you get in on themes inside of indexes because, well, themes are going to manifest as trends on charts. So, momentum investing can work quite well as a supplement to your main approach.
For example, one may theoretically pick some steady blue chips like Coca-Cola, Disney, P&G or a broad based passive ETF as the base of their strategy. These firms could do well in the background. Then, you can try getting in on some thematic momentum (think SaaS, Cloud Computing, Work from Home stocks, A.I., Fintech, etc.) to see if you can earn some higher returns. At best, you could see some nice profits. At worst, if you do it right, you might lose money you can afford to lose.
In short: momentum investing can be helpful on its own, but adding it to your core strategy is even better due to how it can perform well, quietly in the background of your other investment activities.
Momentum can “stall out” when the market shifts from one theme to another
Themes aren’t forever. They might have tons of momentum for a while, but eventually, people pull their capital out of these themes. Said themes sputter out either gradually or suddenly.
Think of tech in the 90s (specifically, the dot-com bubble), finance during 2004-2007ish, and cyclicals from 2009-2014–plenty of momentum for a while, but all good things come to an end. Today, we’re seeing a run in tech, especially after the pandemic, but that too shall eventually slow down.
Although momentum investing is a technical strategy, there is some benefit in keeping an eye on themes that are ending and starting. Pulling out of a big momentum trend before it ends can maximize the capital you have in order to gain exposure to the next big thing.
Is momentum investing worth a try?
Momentum investing is counterintuitive—you won’t hear most finance experts saying buy once something has positive momentum and sell when that momentum wanes. Some investors and traders have seen great success, but only by sticking to some rules and keeping their emotions out of things. While it’s not foolproof, it can work well as an overlay. So, is it right for you?
We can help you figure that out. At Monument Wealth Management, we work hand-in-hand with you to co-create your very own wealth strategy. We take the time to discover your needs and goals and then create a plan to help you get there, always answering YOUR specific questions, not everyone else’s.
