One of the lesser-known investment strategies out there is momentum investing. Often vilified as an unreliable way to grow your portfolio earnings, this investment strategy can still prove to be quite rewarding. In our article, we’re going to tell you what momentum investing is and cover seven ways to use it effectively.
What Is Momentum Investing?
Momentum investing is a type of investment strategy that seeks to make a net profit from the stock market based on trading momentum. What separates this strategy from others is that you generally avoid looking at valuation markers like PE statements and annual growth reports.
Instead, investors use a variety of charting tools to gauge the direction a stock is moving for periods ranging from several days to several weeks. Using these charts, they attempt to predict if stocks will continue rising or falling and price. In addition to charts, momentum investors tend to rely heavily on consumer sentiment to make their trading decisions.
With momentum investing, the duration of trades is generally shorter than what we see in traditional investing. For many professional traders, they may complete multiple trades for the same stock several times throughout the day during particularly busy periods.
1) Stay on Top of Social Media
One of the biggest tips we have to offer for momentum investing is to stay on top of social media. With traditional investing, you typically want to avoid investing based on consumer sentiment. The reason for this is that consumer sentiment can quickly change and could thereby erase any gains you may have made with a trade.
On the other hand, you do the opposite with momentum investing. The idea is to attempt to purchase stocks based on the sentiment of consumers. By diversifying your news sources, you can help increase the likelihood of staying on top of emerging market trends as they develop.
2) Set a Comfortable Loss Level
Another lesson that is extremely important to remember when investing is to set a comfortable loss level. With any investment strategy, there is a realistic potential for losing money instead of gaining it. With momentum investing, the chances for losses are increased due to the volatile nature of this type of trading behavior.
The exact loss level will vary from person to person. The range is usually based on their financial situation and the period of the loss level. To set one that is safe for you, always make sure that you only invest what you are comfortable losing. On top of that, make sure that you can regain what is lost relatively quickly.
3) Reign in Brokerage Fees
With any type of stock trading, brokerage fees can begin to add up relatively quickly. However, the large-volume nature of momentum investing can quickly rack up commissions and other relevant fees much more quickly than other traditional long-term investment strategies.
To combat this, consider using an investment service with decreased costs for traders with large volume. The exact costs reductions you will achieve will vary based on the stock brokerage firm that you use. Most users will begin to see reductions in total commission charges once they have processed 100 trades or more each month.
4) Understand Trendlines
While there are a lot of different reports you can use with momentum investing, the most common one is likely the trendline. In short, a trendline is basically a movement indicator. It is usually drawn over pivot highs and pivot lows to show the general direction a stock is moving in.
Using these indicators, momentum investors attempt to find stocks that are quickly rising or falling in price to make a profitable trade. The exact date range for the report can vary significantly. However, most momentum traders choose to use trend reports that cover much shorter time periods ranging from a few days to weeks at most.
5) Remember the Difference Between Value and Momentum
When investing in stocks, both value and momentum can play a very important role in earning you a decent profit from your trades. However, these two terms are very different. They can not be used interchangeably when you are practicing momentum investing.
With value, you are generally focused more on the long-term picture of a stock. Factors that can impact a value-based decision include earnings statements, PE ratios, and trading volume. With momentum, you are more focused on the quick return that a stock may offer you. Your goal should always be short-term. As a result, you must adjust your strategy frequently to compensate for changes in the investment environment.
6) Play the Long Position
Playing the long position is the simplest method that many new users stick with when starting momentum investing. As the name implies, a long position involves purchasing a stock in the hopes that it will continue rising in the near future. As the stock continues to rise, you continue to make a profit.
With momentum investors, the holding period is generally much shorter than that of other investors. A momentum investor may only hold onto a stock for a period of several days to several weeks before selling it and moving onto another profitable trade.
7) Utilize Short-Sells Efficiently
What separates newer momentum investors from experienced ones is the use of short-sells. Unlike long position trading, the goal of short-sells is to make a net profit from a general decline in the overall value of a stock. To accomplish this, investors sell stocks that they do not currently own. These types of transactions are classified as margins. These are under much stricter requirements than typical trading options.
It’s important to understand that your overall short-selling limit will be capped by a variety of factors. These agents can be your total credit line with the investment brokerage. If you have any questions, always consult with your brokerage service before starting any margin-based transactions.
Just like any investment strategy, it’s important to understand the risks as well as the rewards before proceeding. With momentum investing, there is the potential to make money from stocks that are experiencing large amounts of growth as well as decline.
Just remember to proceed cautiously. Always do your research before making an investment decision to help minimize the risk of your valuable capital. If you have any experience with momentum investing you would like to share, feel free to tell us about them in the comments section.