Momentum Investing – Sin or Strategy
Ambhimanyu, the son of Arjuna had knowledge of entering the Chakravyuha but not the knowledge of coming out. This ended up with him getting killed and while the story being one of good and bad tries to magnify how the bad came together to kill him, the point that is missed is that he knew when we went in that he did not know the way out.
Investors in markets are in many a way Ambhimanyu’s . They know how to enter and hope that somehow they can exit before getting killed. But then again, the bad guys (Brokers, Operators, FII’s) all gang up and kill the poor little investor and snatch his monies.
Momentum Investing has its non-believers but I was kind of astonished to see that in a Document brought out by the Library of Congress whose ideas seem to be subscribed by the SEC (US Equivalent of India’s SEBI), one of the 9 sins they lay out which derail investors is “Momentum Investing”
The biggest misconception in my opinion about investing is that the style is seen to be dictated by the price move rather than knowledge of the style. Just like buying a stock that is falling doesn’t make one a Value Investor and Buying a stock that is going up doesn’t make one a Momentum Investor though it may seem to be very close to the idea.
The key to success in Momentum Investing is not about Entry but about Exits. A Momentum Investor exits a stock that stops seeing positive momentum – whether this is temporary or permanent is time will tell.
A common misconception is that Momentum Investing is about buying stocks regardless of whether they are fundamentally strong or not. But the irony is that rather than we being the deciders on whether a company is good or not, we allow the other participants through their actions dictate whether a stock A is good or not. What could be more democratic an idea than that?
I am a momentum investor and yet there are quite a few stocks that are having the strongest momentum yet not part of my portfolio. Momentum Investing doesn’t need to be about just blindly buying stocks that have gone up the most.
Look at the table below – these are stocks that have the best “Momentum Score” if you used a long term look back. If your portfolio has such stocks, are you a Value / Growth Investor or a Momentum Investor?
Hi Prashant,
Please refer to the following lines from your article:
“I am a momentum investor and yet there are quite a few stocks that are having the strongest momentum yet not part of my portfolio. Momentum Investing doesn’t need to be about just blindly buying stocks that have gone up the most.”
I would like to ask why? If the mentioned stocks are those having strong momentum, why are they not part of your portfolio?
Looking in your blog to find the answer of a question,”Which rules/yardsticks should one follow to take an entry/exit following momentum?”
I found your articles quite interesting and well thought.
Hi,
Thanks for reading 🙂
While I choose the Top 30 stocks when I created the portfolio the first time, when it comes for time to rebalance, I use the concept of Worst Rank Held (https://www.amibroker.com/guide/afl/enablerotationaltrading.html). The idea is that if the rank of a stock drops to say 39 and I am saying that anything upto Rank 40 is acceptable, the stock with Rank 39 won’t be replaced.
The question is Why?
1. As portfolio size moves up, you have an additional parameter to look at. What is the cost of every transaction (not just Brokerage and levies but also Slippage, especially if stock is not very liquid). So, rather than getting the stock out because it fell a couple of ranks, I give it a leeway.
2. The reason for leeway is because I am ranking on relative basis. So, even if this stock has done good, if something else has done better, this stock will move down. I have done back-test using strict rule just to check the differential in returns between what system would have generated sticking to the top 30 only and am comparing the same with the rules I am applying is generating.
Difference as of now is very limited, but I will need to observe over a much longer period to be sure which is the right approach. On a small portfolio I think sticking won’t impact it big time either.