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By M. Isi Eromosele
Momentum is the tendency of investments to exhibit
excellence in their relative performance. Investments that have performed
relatively well, continue to perform
relatively well; those that have performed relatively poorly
continue to perform relatively poorly. Momentum is about much more than buying
a handful of hot stocks; it is a disciplined, systematic investing style that
applies across asset classes.
Virtually all investors can expect higher risk-adjusted
returns by adding momentum to their portfolios. Growth investors will see that
momentum delivers much better performance. Value investors will find momentum
to be an effective complement.
Value-growth investors will want to consider momentum as an
alternative to their growth
allocation.
Momentum is the tendency of investments in every market and
asset class to exhibit upward mobility in their relative performance for a
period of time.
When applied to stock picking, momentum investing, like
value or growth, is about relative performance among specific stocks, not about
overall trends in the market. It works whether a market is in an upswing or
downswing.
Momentum can be used to identify securities likely to
outperform, making it a powerful investment tool. It is also negatively
correlated to value investing, making it an effective diversification
component. Regardless of investment philosophy, practically all investors could
benefit from improved risk-adjusted returns by including momentum investing.
The idea of
selling losing stock investments and buying winners is seductive, but it flies
in the face of the tried and true Wall Street adage, which has perennially been
"buy low, sell high.” The philosophy behind
momentum investing, however, is that more money could be made by "buying
high and selling higher," than by buying underpriced stocks and waiting
for the market to re-evaluate them.
A momentum
investor believes in selling the losers and letting the winners rise, while
re-investing the money from the losers in other stocks that were beginning to
rise.
Momentum investing takes
advantage of market volatility by taking short-term positions in stocks that are
going up and selling them as soon as they show signs of downward trend, then
moving the capital to a new position. In this case, the market volatility
is like waves in the ocean and a momentum investor sails up the crest of one,
only to jump to the next wave before the first crashes down again.
A momentum investor looks to
take advantage of investor herding by leading the pack in and then being the first one to
take his money out.
Momentum investing can be
very profitable. If for example, you buy a growth stock that rallies from $20 to $35 on a glowing analyst
report and then sell before the correction, you'll earn a profit of 50 percent. This is not
the annualized return, but the return from a position that may have been only a
week or a month old.
Momentum
investing can work, but it is may not be practical for all investors. As an
individual investor, a person without a direct link to a major exchange, practicing
momentum investing will most likely lead to overall portfolio losses.
When you purchase
a stock that is rising or sell a stock that is falling, you will be reacting to
older news than the professionals at the head of momentum investing funds. They
will get out and leave you and other unlucky folks holding the bag. If you do
manage to time it right, you will still have to be more conscious of the fees
from turnover and how much they will eat up part your returns.
Momentum trading
is not necessarily for everyone, but it can often lead to impressive returns if
done properly. It takes strong discipline to trade in this type of style
because trades must be closed at the first sign of weakness and the funds must
be immediately placed into a different trade that is showing strength.
Factors, such as
commissions, have made this type of trading impractical for many average traders,
but this is gradually changing as low-cost brokers take on a more influential
role in the trading careers of short-term active traders. Buying high and
selling higher is momentum traders' enviable goal, but this goal does not come
without its fair share of challenges.
M. Isi Eromosele is
the President | Chief Executive Officer | Executive Creative Director of Oseme
Group - Oseme Creative | Oseme Consulting | Oseme Finance
Copyright Control © 2012
Oseme Group
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