Blog 4 - Momentum Investing Explained Momentum investing is an investment strategy that aims to capitalize on the continuance of existing trends in the market. To participate in momentum investing, a trader takes a long position in an asset that has shown an upward trending price, or the trader short-sells a security that has been in a downtrend. The basic idea is that once a trend is established, it is more likely to continue in that direction than to change direction and move opposite against the trend. Breaking Down 'Momentum Investing' Momentum refers to the tendency for stock prices to move in the direction of the trend. Moving against the trend means that the trader must be good at identifying market reversals. Momentum vs Value Value is a long-term strategy, whereas momentum is a short-term strategy. There is room for both philosophies in the stock selection process, but these are two fundamentally different investment strategies. The value investor believes that a stock can become overvalued or undervalued based on relative earnings or discounted cash flow measures. In this way, the fundamental analyst is more interested in the direction of sales and expenses than price. If the price is down and the price-to-earnings (P/E) ratio suggests the stock is undervalued, value investors want to buy – in other words, the company dictates price, not the emotion of the investor or market. The momentum investor is not concerned with operational performance, at least not from a pricing perspective. Momentum investors are technical analysts who thrive on investor emotion. They look at indicators that help to track the trend of a stock and spend a great deal of time looking for patterns that confirm trend continuation. Momentum Tools There are a number of momentum indicators traders use in addition to monitoring the movement of price. The most basic and common tool is the trend line, which is drawn between two points on a price graph. If the line is going up, the trend is up, and momentum investors see this as a buy signal. If the line is sloping down, the trend is down, and momentum investors see this as a sell signal. Another tool traders use is the 50-period moving average. When the price drops below the 50period moving average, it is a confirmation that the price is trending down and a signal for momentum investors to sell. Likewise, when the price moves above the 50-period moving average, it is a confirmation the price is trending up and the is a signal for the momentum investor to buy. Momentum is the rate of acceleration of a security's price or volume. In technical analysis, momentum is considered an oscillator and is used to help identify trend lines.
In general, momentum refers to the force or speed of movement; it is usually defined as a rate. In the world of investments, momentum refers to the rate of change on price movements for a particular asset – that is, the speed at which the price is changing. Breaking Down 'Momentum' Once a momentum trader sees acceleration in a stock's price, earnings or revenues, the trader will often take a long or short position in the stock in the hopes that its momentum will continue in either an upward or downward direction (depending on the trader’s own goals). This strategy relies on short-term movements in a stock's price rather than fundamental value.