What is Momentum Investing
Momentum investing involves a strategy to capitalize on the continuance of an existing market trend. It involves going long stocks, futures, or market ETFs showing upward-trending prices and short the respective assets with downward-trending prices.
BREAKING DOWN Momentum Investing
Momentum investing holds that trends can persist for some time, and it’s possible to profit by staying with the a trend until its conclusion. For example, momentum investors that entered the U.S. stock market in 2009 generally enjoyed an uptrend through 2018.
Momentum investing usually involves a strict set of rules based on technical indicators that dictate market entry and exit points for particular securities. Momentum investors sometimes use two longer-term moving averages, one a bit shorter than the other, for trading signals. Some use 50-day and 200-day moving averages, for example. The 50-day crossing above the 200-day creates a buy signal. A 50-day crossing back below the 200-day creates a sell signal. A few momentum investors prefer to use even longer-term moving averages for signaling purposes.
Another type of momentum investing strategy involves following price-based signals to go long sector ETFs with the strongest momentum, while shorting the sector ETFs with the weakest momentum, then rotating in an out of the sectors accordingly.
Still other momentum strategies involve cross-asset analysis. For example, some equity traders closely watch the Treasury yield curve, and use it as a momentum signal for equity entries and exits. For example, a 10-year Treasury yield above the two-year yield generally is a buy signal, whereas a two-year yield trading above the 10-year is a sell signal. Notably the two-year vs. 10-year Treasury yields tend to be a strong predictor of recessions, and also has implications for stock markets.
In addition, some strategies involve both momentum factors, and some fundamental factors. One such system is CAN SLIM, made famous by William O’Neill, founder of Investor’s Business Daily. Some may argue it’s not a momentum strategy, per se. However, the system generally seeks stocks with both earnings and sales momentum, and tends to point to stocks with price momentum, as well. Like other momentum systems, CAN SLIM also includes rules for when to enter and exit stocks, based mainly on technical analysis.
Momentum Versus Value
Few professional investment managers make use of momentum investing, believing that individual stock picking based on an analysis of discounted cash flows and other fundamental factors tends to produce more-predictable results, and is a better means of beating index performance over the long term.
However, there is some evidence in support of momentum investing. For example, the American Association of Individual Investors shows that, as of October 2017, CAN SLIM beat the S&P 500 in the trailing five-year and 10-year periods, and has beaten it soundly over an even longer time frame.