Do you want to buy stocks at a lower price and sell them when their price rises? It is the right approach to earn higher returns over time. However, some investors aim to buy stocks at a higher price and sell them at an even higher price to make profits. It is called momentum investing, and you may use this approach to make money in the stock market. Should you try the momentum investing strategy?
What is momentum investing?
Momentum investing is the opposite of the buy-low sell-high approach in the stock market. It is based on the approach that stocks currently doing well will continue to do so shortly.
For instance, you may invest in the best-performing stocks in the past six months with the hope that they will continue to outperform for the next six months.
Consequently, you could short the worst performing stocks over the past six months for the next six months to earn a higher return in the stock market. Short selling is an approach where you sell shares you don’t have in your Demat Account through a margin account.
You will have to borrow shares from your stockbroker by paying a margin fee. It helps to ensure that you return the borrowed stocks to your stockbroker at the end of the settlement cycle, which is one day in the case of stocks. The idea of short selling is that the price of a particular stock will come down, and you may earn a profit from the decline in the share price.
Should you try momentum investing?
You could try momentum investing if you are a market-savvy investor with higher risk tolerance. Moreover, momentum investing may be apt when the stock markets outperform. The momentum investing approach is not biased towards a particular sector, market capitalisation or stock.
It involves chasing momentum where different sectors may pick up momentum at different instances in the business cycle. Momentum investing is vulnerable to market volatility which is the fluctuations in the stock market. It involves risking money on the success of stocks based on only one approach: the momentum strategy.
For example, the momentum strategy did not do well during the stock market crashes of 2000, 2008 and 2020. Moreover, you could suffer huge losses if you follow the momentum approach and the stock market crashes.
Market experts advise that you limit maximum portfolio exposure in momentum funds to 10%-20%. However, many investors restrict portfolio exposure in momentum funds to around 5%, which is not a meaningful exposure to this approach.
The momentum approach is a concentrated strategy where you don’t enjoy the protection of diversification. For instance, diversification spreads your investment across sectors and industries, protecting you from extreme volatility in the stock market. In a nutshell, momentum investing may offer higher returns if you can handle risks and stick with the approach for some time.
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I write to make complicated financial topics, simple. Writing is my passion and I believe if you find the right words, it’s simple.
