Momentum Investment Strategy: A Quick Overview

Momentum investing is a strategy that aims to capitalize on the continuation of existing trends in the market. The idea is to buy assets that have performed well recently and sell those that have underperformed, assuming that winners will continue to rise and losers will keep falling, at least in the short term.

Key Principles of Momentum Investing:

Trend-Following:

Buy assets when they show upward momentum (rising prices).
Sell or avoid assets showing downward momentum.

Relative Strength:

Rank assets by their past performance over a specified period (like 3, 6, or 12 months).
Invest in the top performers and periodically rebalance the portfolio.

Risk Management:

Cut losses early if the trend reverses (through stop-loss orders).
Diversify investments across multiple sectors or asset classes to manage risk.

How It Works:

Stock Selection:

Look for stocks, ETFs, or sectors with high relative strength.
For example, a stock that has gained 20% in the last 6 months may qualify as a buy candidate.

Performance Analysis Period:

Common look-back periods: 1 month, 3 months, 6 months, or 12 months.
Some investors may also monitor shorter timeframes to detect early momentum shifts.

Rebalancing:

Portfolios are often rebalanced monthly or quarterly, replacing weaker performers with stronger ones.

Momentum Investment Strategy Advantages:

Capitalizes on Trends: Profits from persistent market trends driven by investor sentiment.
Easy to Implement with ETFs or Stocks: ETFs tracking momentum indices can simplify the strategy.
Systematic Approach: Reduces emotional decision-making by following predefined rules.

Challenges:

High Volatility: Momentum investing can be risky during market reversals or corrections.
Overtrading Risk: Frequent rebalancing can lead to high transaction costs.
Requires Discipline: Sticking to the strategy through volatile periods can be difficult.

Practical Example:

12-Month Momentum Rule:
An investor reviews a list of stocks or ETFs every month, looking at their performance over the past 12 months.
They buy the top 10% of performers and remove any stock that drops below the 50% mark in the next review cycle.

Popular Momentum ETFs:

These funds track indices composed of stocks with strong momentum, offering easy access to the strategy for retail investors.

Momentum investing requires strict rules and discipline, as trends may reverse unexpectedly. But with the right execution, it can generate strong returns, especially in bull markets where trends tend to persist for longer.