Momentum Stocks
Momentum is the measurement of the speed or velocity of changes.
Stock Momentum
Momentum Stocks is the speed with which its price changes. Incase of a rise in prices it is said to have upward momentum, incase of a fall in price it is said to show a downward momentum.
Using Stock Momentum
The momentum of a particular stock is calculated and then compared with the momentum of other stocks. When the momentum of a stock starts outperforming the others it is easy to understand that aggressive buying is taking place and a dramatic increase can be expected over the next two to three weeks. This is the time to enter the stock. The stock will be exited once its momentum is outperformed by other Momentum Stocks. This will often mean getting out while the price is still rising. This is contrary to the more common practice of selling after a drop in price.
Investing in Momentum Stocks or Momentum Investing
Somehow Momentum Stocks investing is always referred to with a little derision and considered by many to be of dubious reputation. However it has its plus points and is known to give above expectations returns at times.
Since investors putting in their money in momentum stocks aim high, ordinary steady returns do not attract them. They aspire to double or triple their investments in a few months time. While investing, they are on the look out for stocks that have already outperformed the market; strong historical earnings growth and positive earnings growth forecasts. Investors typically screen the stocks for those that best meet their requirements and then decide on the ones in which to put their money.
Momentum investing however causes discomfort for efficient market theorists. Its basic assumption is that trends exist and they continue. If a stock has performed well in the recent past it will continue to do so in the near future also. This may seem too simple and basic to work, but surprisingly it does.
Often people do not realize the awesome power
of compounding. To emphasize, if one were to double a penny every day for thirty days at the end of the period it will be worth $10,700,000! This sort of multiplying effect, which is nothing but simple compounding is what attracts certain investors to this class of stocks known as momentum stocks. It is the stocks of the fastest growing companies. These companies lead virtually all other companies in terms of sales growth, operating margins, profitability and strong fundamentals. Often businesses that the general public patronizes are the ones that have given stupendous returns. For example, everyone shops at Wal Mart, but many may not have noticed that in the last Bull Run the stock of Wal Mart rose by 40,232%, that would have turned $10,000 into more than $4 million. The stock of Microsoft rose by 61,034% since the 13 years following its IPO. That would have turned $10,000 to $6.1 million. However these companies are far too big now to grow at such astronomical rates. So if one wants to really make it big one needs to locate and invest in the most rapidly growing companies NOW, when they are at the take off stage.
Knowing when to sell
Investors in momentum stocks cannot follow the buy and hold strategy. They monitor their holdings daily and at the maximum hold the stock for a few months.
Knowing the right time to enter a stock is not as difficult as is knowing the right time to exit it. It needs to be understood that momentum stocks will get trampled badly if something goes wrong. Therefore, investors in such shares must act quickly at the first hint of trouble. The trigger to exit the stock can be found in various indicators, broadly a weak price chart is a sell signal; any bad news from disruption in production to an accounting scandal will give a signal to exit; any reversal in growth forecasts is a clear signal to sell.
What causes stock momentum
While the existence of stock momentum is well accepted, the reasons behind it are often debated. It is often said that the primary cause of momentum in stocks is a psychological tendency of investors to hold on to the losing stocks too long and to sell the winners too soon. This acts as a trigger for momentum. Actually what happens is that the price of a stock may go down because of some bad news relating to the company. But there are investors who do not wish to sell their holdings at a loss. These stockholders keep holding on to their stocks hoping to exit when the price will rise later. However if too many persons are of this opinion and continue to hold on to their Momentum Stocks then the stock price will not reflect the bad news effectively. When this happens some investors note that this stock is overvalued and so short sell the stock, assuming that prices will fall shortly. This cycle will push prices of the stock down thus creating the momentum effect.
A similar situation will arise when some good news propels the share prices of a particular stock higher. Many investors will decide on selling to capture the gains. If this happens fast the prices will not rise to the level it should based on the good news. This will make new investors come in creating the upward momentum in prices.
Conclusion
Momentum Stocks, if picked correctly after following a rational screening process surely gives above average returns. However, such investment is not for amateurs. One needs to understand the market, be ready to do a certain amount of study and analysis and always be alert as to when to enter and more important when to exit the stock. It is well known that risk and reward go hand in hand. If you are aiming high then you must accept high risks. If you are unsure of your ability or capability to take on high risks, then you should be satisfied with low return also.
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