Understanding Momentum Investing

Several different styles of investing can be used by modern investors. One such style is momentum investing. Momentum investing is not a new idea. Investors have been noticing momentum-based behaviour in the financial markets for centuries. Let’s dive into what momentum investing is and how it works.

What is Momentum Investing?

Momentum investing works on the premise that stocks that have been doing relatively well are likely to keep doing well. Essentially, the price “momentum” of the stock can be used to gauge the future direction of the stock.

Momentum investing involves buying stocks that have been delivering good returns in the recent past and aiming to sell them at even higher prices. While the concept of momentum is usually applied to individual stocks, it can also be effectively applied to sectors as well as the market as a whole.

A momentum strategy targets stocks that are currently potentially performing well just like how in cricket, the batsman in form plays well when the weather conditions and the pitch are favourable.

Benefits and potential Risks Involved in Momentum Investing

It’s important for investors to know both the benefits offered by momentum investing as well as the potential risks involved:

Benefits

• Leverages Investor Behaviour – Momentum investing works based on confirmation bias. Since investors underreact to market news that goes against their existing beliefs, a positive trend is likely to remain a positive trend.
• Wider Opportunity – Momentum investors can leverage a secular investment approach that does not depend on specific sectors. It allows investors to take part in positive market trends from a wide universe of stocks.
• Outperforms in Bullish Markets – When the market has a strong bullish sentiment, it helps momentum investors identify and capitalize on the momentum that can lead to potentially better returns.

Potential Risks

• Requires Constant Monitoring – One of the drawbacks of momentum investing is that it requires constant vigilance and monitoring. Reacting appropriately and quickly to relevant market signals can be difficult for non-professional investors.
• Higher Transaction Costs – Momentum strategies involve entering exiting investments at a relatively higher frequency which can lead to added transaction costs for the investor.

How Does Momentum Investing Work?

Momentum investing relies on a few crucial indicators.

• Price – The quicker the price of a stock changes in a single direction, the stronger the price momentum. If the price is moving quickly in a particular direction, then it indicates that market sentiment is strong and is likely to remain strong in the near future. Hence, momentum investors can potentially benefit when market conditions are bullish.
• Volume – The higher the volume of trading in a stock, the stronger the momentum. If a high number of people are buying a stock, then it is more likely that the positive trend will continue. That’s why momentum investing becomes easier during periods when there is high volume.
• Earnings – Momentum investors rely on changes in the earnings per share (EPS) of a stock as a key indicator. If the EPS of a stock is growing at a fast pace, it indicates that earnings are favorable which makes positive stock movement more likely.

Wrapping Up

Momentum investing is a widely-used investing style. It is popular amongst investors who can spot stock trends and take quick action. Momentum investing requires flexibility and adaptability and can deliver outsized returns depending on market conditions.

This document represents the views of Axis Asset Management Co. Ltd. and must not be taken as the basis for an investment decision. Neither Axis Mutual Fund, Axis Mutual Fund Trustee Limited nor Axis Asset Management Company Limited, its Directors or associates shall be liable for any damages including lost revenue or lost profits that may arise from the use of the information contained herein. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

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Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.