When value or growth investing fails to fetch sustained profits, one should explore another time-tested winning strategy that simply bets on the frontrunner stocks. Translated, one of the most successful strategies today is to get in on momentum stocks at the right time.
At the core, momentum investing is buying high, selling higher. It is based on the idea that once a stock establishes a trend, it is more likely to continue in that direction than move against the drift. Thus, this strategy calls for hitching a ride on an already fast-moving train, without fretting about valuations or growth prospects. But why does the momentum strategy work?
There is a simple reason behind this. It works because we are humans!
There’s a whole laundry list of behavioral biases that most investors exhibit and these emotional responses and mistakes are the very reason that momentum strategy works. For instance, there are investors who are anxious about booking losses and hence hold on to losing stocks for too long, hopeful of a rebound in the prices. On the other hand, a few investors sell their winners way too early.
Furthermore, investors initially tend to under-react to news, events or data releases. However, once things become clear, they tend to go with the flow and overreact, causing dramatic price reactions.
These behavioral problems extend trends, and thus open up huge opportunities for momentum players. So basically, it’s a way to profit from the general human tendency to extrapolate current trends into the future.
Momentum investing is thus based on that gap in time that exists before the mean reversion occurs, i.e. before prices become rational again.
Momentum strategies have been known to be alpha-generative over a long period of time and across markets. So obviously, this strategy is quite tricky to implement, as detecting these trends is no child’s play.
Here, we have created a strategy that will help investors get in on these fast movers and make handsome gains. Our screen will help you benefit from both long-term price momentum and a short-term pullback in price, which would reflect some profit-taking in the stock.
