Momentum investing is simply buying stocks that have been doing well lately, and selling those that haven't. It turns out that over the last several years, strategies which buy "momentum stocks" (stocks which have risen significantly in price over the last 6 months - 1 year) in general have outperformed the market as a whole. However there's no fundamental reason to believe that this trend will continue indefinitely. In the stock market, trends come and go. Some trends can even last several years or decades, but when it becomes TOO well-known, too many people try leveraging it to their advantage, theoretically to the point where it's no longer a trend. In fact if there are more-than-enough people leveraging it, it will become a disadvantage! If the "momentum effect" stopped working today, it would take several years for people to even realize it. And by that time, it just might start working again!
If you read the academic literature (and I admittedly have read some of it, being the nerd I am), you'll see that most "experts" (mostly professors of finance at fancy business schools) have concluded that the momentum effect is due to a time lag between news and price. This is to say that, for example, if a bunch of positive news events happen to a company, it will tend to take the market some time (on the order of a few months to a year) to fully incorporate that good news into the price. I tend to believe this is true, and if you do too, then instead of looking for momentum stocks, you should be looking for "good-news" stocks, since it is the good news which CAUSES the momentum effect in the first place! Momentum is simply a secondary effect of good news, so looking for good news will give you a cleaner signal.
My biggest issue with momentum investing is the fact that it inherently buys high (you're only buying a stock after it has done well) and sells low (after it no longer has good momentum, a.k.a. after it has dropped). This is in direct contrast to the most basic common sense law of investing "buy low, sell high" which I believe is a much more fundamentally sound way to invest. Momentum investors have the mantra "buy high, sell higher", but the obvious flaw in that logic is the simple fact that no stock goes up forever. There will be a day when every inflated stock goes back down, but those with speculative tendencies like to think that they can get out before that inevitable fall begins -- of course trading is a zero-sum game, so sometimes their timing is lucky, and sometimes it's not. If you invest based solely on momentum, then you will inevitably continue holding onto the stock as it rises and rises, and only sell that stock after there's been a significant fall in price from the top, so you're likely to be one of those with the "unlucky timing."
Value investing more closely follows the "buy low, sell high" philosophy. You're looking to invest in stocks which are "cheap" which is to say they have low ratios of price-earnings, price-book, price-sales, price-cash flow, etc. Basically any ratio with "price" in the numerator is considered a measure of expensiveness, so "value stocks" are those with low ratios. These stocks are often those whose prices have been beaten down in the last year or several years, and as a result, "value" and "momentum" are inversely-correlated. This is to say that value stocks TEND to have bad momentum, and momentum stocks TEND to have bad value. The funny thing is that as a group, value stocks ALSO have outperformed the overall market historically. So you have two different strategies, both of which are market-beating, but which are negatively-correlated to each other! Therefore my personal opinion is that if you want to implement a momentum investing strategy (and I'm not necessarily saying you should), it would be prudent to find stocks with both good value AND good momentum. The momentum may help avoid what some people call "value traps" which are essentially cheap stocks which remain cheap indefinitely. The value ensures that even though this stock has risen substantially, it's still not overpriced and therefore has room to move before becoming inflated. Now because value and momentum are negatively-correlated, it's not so easy to find stocks with both great value and great momentum, but there are some of them out there, and those are the ones you may want to consider buying.
However, far more important than any of that value/momentum stuff is simply making sure the underlying company itself is actually a solid investment, as well as avoiding emotional reactions to the random-noise fluctuations of the stock and overall stock market by buying/selling at inopportune times. It seems like an obvious point to make, but investors have the tendency to look at a stock as just a moving ticker signal, rather than looking at it as an actual living and breathing company that produces actual goods and/or services. There are many people out there who will blindly buy stock with good "technical signals" with complete disregard as to whether the company itself is any good. When they make a profit, they believe it is due to their "technical skill", and when they lose money, they believe it was an isolated unlucky event. The problem with their logic is that often on the other side of every trade was ANOTHER "technical analyst" who ALSO thinks he's right! But only one of them can be right! So in the end, if you trade too often, you just incur high transaction expenses, which are generally not worth it (unless you're a better-than-average trader -- but of course EVERY trader thinks that he is better than average, or he wouldn't be trading in the first place!!)
Back to the main point: I believe a good way to implement a value/momentum strategy would be to compile a list of maybe 80-100 "solid businesses" (disregarding value and momentum), THEN ranking them based on some combination of value/momentum, and buying the top 10-20 on the list, and then holding onto them for an average period of at least a few months, if not longer. Buying too few stocks will expose you to a high degree of volatility, but buying too many stocks will guarantee mediocre returns, since some of the stocks you're buying aren't at the top of your list.
Investing is not an easy thing to do, and there are many predators out there in the stock market trying to take your money, so make sure to do your research if you decide to become a stock picker. Otherwise, the much more simple (and far less time-consuming) way to invest is to just put your money into a low-cost index fund, which I believe is the way to go for the majority of individuals.
If you read the academic literature (and I admittedly have read some of it, being the nerd I am), you'll see that most "experts" (mostly professors of finance at fancy business schools) have concluded that the momentum effect is due to a time lag between news and price. This is to say that, for example, if a bunch of positive news events happen to a company, it will tend to take the market some time (on the order of a few months to a year) to fully incorporate that good news into the price. I tend to believe this is true, and if you do too, then instead of looking for momentum stocks, you should be looking for "good-news" stocks, since it is the good news which CAUSES the momentum effect in the first place! Momentum is simply a secondary effect of good news, so looking for good news will give you a cleaner signal.
My biggest issue with momentum investing is the fact that it inherently buys high (you're only buying a stock after it has done well) and sells low (after it no longer has good momentum, a.k.a. after it has dropped). This is in direct contrast to the most basic common sense law of investing "buy low, sell high" which I believe is a much more fundamentally sound way to invest. Momentum investors have the mantra "buy high, sell higher", but the obvious flaw in that logic is the simple fact that no stock goes up forever. There will be a day when every inflated stock goes back down, but those with speculative tendencies like to think that they can get out before that inevitable fall begins -- of course trading is a zero-sum game, so sometimes their timing is lucky, and sometimes it's not. If you invest based solely on momentum, then you will inevitably continue holding onto the stock as it rises and rises, and only sell that stock after there's been a significant fall in price from the top, so you're likely to be one of those with the "unlucky timing."
Value investing more closely follows the "buy low, sell high" philosophy. You're looking to invest in stocks which are "cheap" which is to say they have low ratios of price-earnings, price-book, price-sales, price-cash flow, etc. Basically any ratio with "price" in the numerator is considered a measure of expensiveness, so "value stocks" are those with low ratios. These stocks are often those whose prices have been beaten down in the last year or several years, and as a result, "value" and "momentum" are inversely-correlated. This is to say that value stocks TEND to have bad momentum, and momentum stocks TEND to have bad value. The funny thing is that as a group, value stocks ALSO have outperformed the overall market historically. So you have two different strategies, both of which are market-beating, but which are negatively-correlated to each other! Therefore my personal opinion is that if you want to implement a momentum investing strategy (and I'm not necessarily saying you should), it would be prudent to find stocks with both good value AND good momentum. The momentum may help avoid what some people call "value traps" which are essentially cheap stocks which remain cheap indefinitely. The value ensures that even though this stock has risen substantially, it's still not overpriced and therefore has room to move before becoming inflated. Now because value and momentum are negatively-correlated, it's not so easy to find stocks with both great value and great momentum, but there are some of them out there, and those are the ones you may want to consider buying.
However, far more important than any of that value/momentum stuff is simply making sure the underlying company itself is actually a solid investment, as well as avoiding emotional reactions to the random-noise fluctuations of the stock and overall stock market by buying/selling at inopportune times. It seems like an obvious point to make, but investors have the tendency to look at a stock as just a moving ticker signal, rather than looking at it as an actual living and breathing company that produces actual goods and/or services. There are many people out there who will blindly buy stock with good "technical signals" with complete disregard as to whether the company itself is any good. When they make a profit, they believe it is due to their "technical skill", and when they lose money, they believe it was an isolated unlucky event. The problem with their logic is that often on the other side of every trade was ANOTHER "technical analyst" who ALSO thinks he's right! But only one of them can be right! So in the end, if you trade too often, you just incur high transaction expenses, which are generally not worth it (unless you're a better-than-average trader -- but of course EVERY trader thinks that he is better than average, or he wouldn't be trading in the first place!!)
Back to the main point: I believe a good way to implement a value/momentum strategy would be to compile a list of maybe 80-100 "solid businesses" (disregarding value and momentum), THEN ranking them based on some combination of value/momentum, and buying the top 10-20 on the list, and then holding onto them for an average period of at least a few months, if not longer. Buying too few stocks will expose you to a high degree of volatility, but buying too many stocks will guarantee mediocre returns, since some of the stocks you're buying aren't at the top of your list.
Investing is not an easy thing to do, and there are many predators out there in the stock market trying to take your money, so make sure to do your research if you decide to become a stock picker. Otherwise, the much more simple (and far less time-consuming) way to invest is to just put your money into a low-cost index fund, which I believe is the way to go for the majority of individuals.
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