What Is Momentum Investing?

Do you have to purchase shares after they’re heating up after which promote them after they’ve cooled off?

That’s the alternative of some standard knowledge, however it’s the essential philosophy behind one investing method that has proven some skill to beat the general inventory market, however not with out some danger.

Momentum investing is an idea based mostly on the thought that you would be able to earn long-term income by using shares whereas they’re on an excellent run, and promoting them as soon as they’ve had an extended unhealthy stretch. Most often, an investor deploying this method will purchase shares which have had excessive returns for between three to 12 months and promote people who have underperformed throughout that very same interval.

It’s unclear who “invented” momentum investing, however it’s broadly acknowledged that Chicago-based fund supervisor Richard Driehaus was one of many first to tout it broadly.

“I imagine that extra money could be made shopping for excessive and promoting at even increased costs,” Driehaus instructed Crain’s Chicago Enterprise in 2004. “I attempt to purchase shares which have already had good value strikes, which can be usually making new highs and which have optimistic relative energy.”

Momentum Investing and Standard Knowledge

There isn’t a broad consensus as as to if momentum investing is a legitimate technique, however the idea gained steam in 1993 after researchers famous within the Journal of Financethat if an investor bought previous winners and bought previous losers, they’d have acquired “important irregular returns” between 1965 and 1989.

Even those that imagine in momentum investing can’t fully clarify why it really works when it does. However, it does fly within the face of some conventionally held philosophies.

Momentum investing is basically the alternative of the outdated adage that traders ought to “promote excessive” and “purchase low.” If an investor purchases a inventory that has had excessive returns over a interval and sells these which were performing poorly, it’s protected to ask whether or not they’re benefiting from the very best pricing.

Momentum investing additionally goes towards the “purchase and maintain” method, which merely focuses on buying shares of high quality corporations and holding on to them for very lengthy durations.

Momentum Investing Returns

One approach to monitor the success of momentum investing is to have a look at the MSCI USA Momentum Index, which is designed to emphasise shares with rising costs.

Right here’s a take a look at the annual efficiency of the MSCI USA Momentum Index in comparison with its mother or father index, the MSCI USA Index, in addition to the S&P 500, courting again to 2008 (the yr of the monetary disaster).

12 monthsMSCI USA Momentum IndexMSCI USA IndexS&P 500

As you’ll be able to see, the MSCI USA Momentum Index beat the opposite two indexes in seven of the final 11 years. Nevertheless, it’s notable that throughout the yr of the monetary disaster in 2008, the index carried out worse than different indexes. This lends credence to 1 notion that momentum investing can add to progress in periods of excellent inventory market progress, however fails to guard capital properly throughout unhealthy occasions.

“It doesn’t work in each market atmosphere,” famous an article final yr revealed by the UCLA Anderson College of Administration.  “And momentum shares are topic to sharp reversals that may depart trend-followers badly bloodied.”

The right way to Observe a Momentum Strategy

One downside to momentum investing is that it might probably require a great deal of work. Not all traders have the time, vitality, or experience to analysis which shares have been on an excellent run and which haven’t. In actual fact, true momentum investing includes following sure advanced technical indicators that let you know when to purchase and promote a safety.

However, the momentum philosophy could be utilized in a common approach, with traders placing extra money into shares when the general market is doing properly and staying away when it’s not. (In different phrases, don’t fear about choosing particular shares, however experience the tendencies.)

For many who aren’t eager on choosing shares, there are particular securities that observe a momentum method. In recent times, the market has seen a wave of exchange-traded funds that target choosing shares with good latest efficiency.

Examples embrace the iShares Edge MCSI U.S.A. Momentum Issue ETF [BATS: MTUM] and the SPDR Russell 1000 Momentum Focus ETF [NYSE ARCA: ONEO].

These ETFs may also help somebody use a momentum investing method with out deciding on particular person securities. They will additionally make it easier to lower your expenses, because the ETFs will regulate their holdings on their very own, thus releasing you from the commissions and tax implications that always include frequent shopping for and promoting.