Changes in the nature of Momentum Investing

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While some market players are concerned about growing stock price volatility, momentum traders have profited handsomely from the mood swings over the previous year and a half.

 Investing in long-term momentum (5 years or 60 months) and short-term momentum (1 to 3 months) might lead to return reversal in the future. Interestingly in the medium term (6 to 12 months) actually exhibits a continuation of returns explaining the logic if in the medium-term growth trends the stock shows a persistently doing will show continuity in its growth trend or the period of future time and same way if it is continuously performing poorly it will continue to perform poorly as well in the long term. But in the current market situation of high volatility, investors can’t bet on continuation. Thus this has changed the strategies and behavior of investors have changed. 

Momentum Investors are tracking the short term, i.e., 1 to 3 months, to check on the returns, and so the portfolio has to be constantly rebalanced. Also, in this scenario, investors can't over diversify to get the actual value of the momentum (investing in many different stocks). Thus, with fewer stocks in the portfolio, one can adjust the returns by rebalancing. In such circumstances, a momentum trader might expect a 10-15% gain. Before investing in individual equities, one must analyze the sectoral trend. Sectoral breakouts are excellent tools in and of themselves for identifying opportunities in individual stocks, which would not be as successful the other way around since the likelihood of hitting a stop loss is lower than the probability of generating profits. 

 From 1927 to 2014 (87 years), the applied momentum approach on US large-cap and mid-cap stocks generated a 15.8% compound annual growth rate (CAGR%), beating the S&P 500 index, which had a 9.92% CAGR. Higher market volatility means more opportunities to identify trading structures. Momentum investors generally wish to enter a trade as soon as a news shock strikes the underlying security as feasible. 

Thus before placing a wager, momentum investors keep one eye on the media and the other on the crowd and exit when the trend suddenly gets overheated. Substantial volumes, strong sectoral involvement, growing open interest, and media support combine to create an excellent trading environment.

- Shubh Agrawal - NMIMS

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