Momentum Investing: A Complete Guide to Strategies, Stocks, and Profit

Momentum investing is a powerful strategy for maximizing profits by capitalizing on stock price trends. If you’ve ever wondered, What is momentum investing, and how do I use it? this guide has you covered. Whether you're a beginner or an experienced trader, this article will explain everything about momentum investing, from strategies to examples, and how it compares to other investment methods like value investing.

Wikimint and the author, Selvakumaran Krishnan, are not authorized advisors; this content is for informational purposes only.

What is Momentum Investing?

Momentum investing is a trading strategy where investors buy securities that are performing well and sell those that are underperforming. It’s based on the idea that the trend is your friend - meaning that stocks with strong performance in the recent past are likely to continue performing well in the near future.

Momentum Investing Meaning Explained

In simple terms, momentum investors focus on stocks with upward or downward price trends. By riding these trends, they aim to maximize short- or medium-term returns.

For instance, if a stock has risen 10% over the last three months due to strong earnings, a momentum investor might buy the stock, expecting the trend to continue.

Key Momentum Investing Strategies

There are several strategies that traders use to apply momentum investing effectively. Here are the most common ones:

Relative Strength Strategy

This involves comparing the performance of stocks against their peers or a market index. Investors focus on stocks that show higher relative strength.

Example: A stock in the technology sector that outperforms other tech stocks during a market rally may be selected for a momentum portfolio.

Moving Averages

Investors use moving averages (like 50-day or 200-day) to identify price trends. A stock crossing above its moving average may signal a buy opportunity.

Earnings Momentum

Stocks with strong earnings growth often attract momentum investors. Positive quarterly results can drive upward price trends.

Sector Momentum

Certain sectors, like technology or healthcare, might experience strong trends. Investors focus on leading stocks within these booming sectors.

Momentum Investing vs. Value Investing

Many investors compare momentum investing with value investing, but the two strategies are fundamentally different:

Momentum Investing Aspects

1. Focus: Stocks with upward/downward trends.
2. Holding Period: Short to medium term.
3. Risk: Higher risk due to market volatility.
4. Profit Source: Price movements.

Value Investing Aspects

1. Focus: Undervalued stocks based on fundamentals.
2. Holding Period: Long term.
3. Risk: Lower risk with stable returns.
4. Profit Source: Market corrections to true value.

Is Momentum Investing Profitable?

Momentum investing can be highly profitable if done correctly, but it comes with risks. Stocks with strong upward trends can reverse quickly, leading to losses.

Key Factors for Success in Momentum Investing

• Timing: Enter and exit trades at the right time.
• Discipline: Follow strict rules for buying and selling.
• Market Conditions: Momentum works best in trending markets, either bullish or bearish.

How Do I Start Momentum Investing?

If you're new to momentum investing, follow these steps to get started:

1. Learn the Basics: Understand the meaning of momentum investing and familiarize yourself with different strategies.
2. Use Screening Tools: Platforms like screener.in or trading apps help find momentum stocks.
3. Set Entry and Exit Points: Use technical indicators like RSI or MACD to decide when to buy or sell.
4. Build a Momentum Portfolio: Diversify by including stocks from various sectors showing strong trends.
5. Monitor Regularly: Keep track of your portfolio and adjust as needed.

Momentum Investing in India

Does momentum investing work in Indian equities? Absolutely. In recent years, momentum investing strategies have gained popularity in the Indian stock market, especially through Smallcase and ETFs.

Popular Momentum Investing Smallcases in India

• Alphabots Smallcase: Focuses on trending stocks using algorithms.
• Momentum Factor by Windmill: Invests in high-momentum Indian equities.

News Example on Momentum investing:

In 2021, the Nifty Momentum 30 Index, which tracks high-momentum stocks, outperformed the broader Nifty 50 Index by a significant margin.

Who is a Famous Momentum Investor?

One of the most well-known momentum investors is Richard Driehaus, often referred to as the Father of Momentum Investing. He popularized the concept of buying high and selling higher.

Momentum Investing Strategy Example

Let’s look at a simple example:

Suppose a stock in the IT sector shows a consistent 20% rise over three months. If quarterly earnings exceed expectations, momentum investors would buy the stock, anticipating further gains. They might use a trailing stop-loss to minimize losses if the trend reverses.

Best Momentum Investing Strategy

The best strategy depends on your goals and risk tolerance. However, combining multiple techniques—like using relative strength and moving averages—can enhance results.

Pros and Cons of Momentum Investing

Pros

• High potential for quick gains.
• Works well in trending markets.
• Simple strategies based on clear indicators.

Cons

• High risk of losses during trend reversals.
• Requires constant monitoring.
• May not work in sideways markets.

FAQs on Momentum Investing

Momentum investing is an exciting strategy, but it’s natural to have questions before diving in. To make things easier, we’ve answered some of the most frequently asked questions about momentum investing, strategies, and its application in different markets. Whether you're a beginner or a seasoned investor, these answers will help clarify your doubts.

What is momentum investing?

Momentum investing is a trading strategy where investors buy stocks or assets showing strong recent performance and sell those underperforming. The idea is to ride the momentum of price trends for short- or medium-term gains.

How does momentum investing differ from value investing?

Momentum investing focuses on stock price trends, buying high-performing stocks with strong upward momentum. Value investing, on the other hand, focuses on finding undervalued stocks based on their intrinsic value and holding them for long-term gains.

Is momentum investing profitable?

Yes, momentum investing can be highly profitable, especially in trending markets. However, it comes with risks, as trends can reverse suddenly. Success depends on timing, discipline, and market conditions.

Can I earn dividends while investing in momentum stocks?

Yes, you can benefit from dividends in momentum investing, but it's not the primary goal. Momentum investing focuses on capitalizing on price trends, so dividends are more of an added bonus rather than a key consideration. If you invest in high-momentum stocks that also pay dividends, you'll earn the dividend payouts while holding the stock. However, most momentum investors prioritize price movement over dividend yields when selecting stocks.

How do I start momentum investing?

1. Learn the basics of momentum investing and familiarize yourself with key strategies.
2. Use screening tools to identify stocks with strong momentum.
3. Set clear entry and exit points using technical indicators like RSI or moving averages.
4. Monitor your investments regularly and adjust as needed.

What is the best momentum investing strategy?

There’s no one-size-fits-all answer, but combining strategies like relative strength, moving averages, and earnings momentum often yields the best results. The choice of strategy depends on your goals and risk tolerance.

Does momentum investing work in India?

Yes, momentum investing works well in Indian equities. Strategies like Smallcase Momentum or investing in momentum ETFs, such as the Nifty Momentum 30 Index, have shown strong results in the Indian market.

Can Navratna companies be considered momentum stocks?

Yes, Indian Navratna companies can sometimes be considered momentum stocks, but it depends on their stock price trends at a given time. These companies are known for their strong financial performance and strategic importance in India, and they may show momentum if their stock prices experience consistent upward trends driven by factors such as robust earnings, favorable government policies, or sectoral growth.

However, not all Navratna companies automatically qualify as momentum stocks. Momentum investing focuses on recent performance and trends, so whether a Navratna company fits the criteria depends on its current market behavior. For instance, if a Navratna stock outperforms its peers in the energy sector due to high demand for its products, it could be identified as a momentum stock during that period.

What is a momentum portfolio?

A momentum portfolio is a collection of stocks or assets chosen based on their strong price trends. Investors continuously adjust the portfolio by adding high-performing assets and removing underperformers.

Who is a famous momentum investor?

Richard Driehaus is widely regarded as the Father of Momentum Investing. He popularized the idea of buying high-performing stocks and selling them for higher returns.

Is momentum investing good for beginners?

Momentum investing can be suitable for beginners, but it requires discipline and constant monitoring. Beginners should start small, learn how to use technical tools, and focus on risk management.

Can momentum investing be applied to sectors?

Yes, sector momentum is a popular strategy. Investors focus on sectors experiencing strong trends, such as technology or healthcare, and choose leading stocks within those sectors.

What are the risks of momentum investing?

1. Trend Reversals: Sudden price reversals can lead to significant losses.
2. Market Volatility: Momentum strategies are sensitive to market swings.
3. High Monitoring Requirements: Success requires regular tracking of investments.

What is an example of momentum investing in action?

Suppose a tech stock rises 25% over three months due to excellent earnings. A momentum investor would buy the stock expecting the trend to continue. If the trend reverses, they use a stop-loss to minimize losses.

Does momentum trading differ from momentum investing?

Momentum trading involves short-term buying and selling of assets based on intraday or weekly trends, while momentum investing focuses on medium-term trends, holding assets for weeks or months.

What tools are used for momentum investing?

• Technical Indicators: Moving averages, RSI, and MACD.
• Stock Screeners: Tools like screener.in or TradingView help identify high-momentum stocks.
• Market Indexes: Momentum indexes like the Nifty Momentum 30 can guide investment decisions.

Is momentum investing suitable for long-term investors?

Momentum investing is generally a short-term to medium-term strategy. However, some investors use it within a broader portfolio to balance long-term and short-term goals.

Can momentum investing be taken as an online business idea?

Momentum investing can be a good online business idea if approached strategically, but it requires expertise, time, and a disciplined approach. Here's why it can work:

• Low Barriers to Entry: With online trading platforms, anyone can start momentum investing with minimal capital.
• Scalable Potential: If you're successful, you can grow your portfolio over time and even provide premium services like courses, advisory, or a momentum-focused community.
• High Demand for Education: Many people want to learn trading strategies, so offering educational content about momentum investing could be a profitable online business.

However, it’s essential to note that momentum investing involves risks, such as sudden trend reversals and market volatility. If you're considering building a business around it, make sure to have strong expertise, provide value to your audience, and adhere to financial advisory regulations to avoid legal issues. Momentum investing is more of an active trading strategy than a passive business model, but it can be monetized through related online ventures.

Final Thoughts: Is Momentum Investing Right for You?

Momentum investing is not for everyone. It requires discipline, market knowledge, and risk tolerance. If you're someone who can act quickly and manage risk effectively, this strategy might be a good fit for you.

Whether you’re exploring momentum investing stocks or learning about strategies and stock market facts in India, this guide gives you all the tools to succeed.