• Momentum investing is a strategy where investors acquire assets, such as stocks or bonds, that consistently exhibit upward price trends while divesting assets experiencing declining prices.
• The fundamental premise of momentum investing lies in purchasing assets on the rise with the expectation that their positive momentum will endure.
• This strategy aims to capitalize on the potential for further price increases, enabling investors to sell these assets at higher values in the future, thereby generating profits.
• Conversely, assets witnessing a downward trajectory are sold, anticipating that the decline will persist.
• The underlying philosophy of momentum investing rests on the belief that identifiable trends exist in asset prices and that these trends demonstrate a tendency to persist over time.
• By recognizing and engaging with these trends early on, investors seek to leverage the continued momentum for substantial gains in their investment portfolios.

3. Momentum Investing vs. Traditional Wisdom

Departure from Tradition

Traditionally, investment experts have advocated for buying assets during market downturns, especially in times of financial crises when fear among investors leads to prices well below intrinsic value. This conventional wisdom suggests that selling these undervalued assets during a bull market can yield substantial profits. In stark contrast, momentum investing follows a "buy high, sell higher" philosophy, with investors often entering positions in assets reaching new all-time highs, even when trading well above intrinsic values. Numerous academic studies indicate that momentum investing can deliver impressive returns, outperforming benchmark indices.

Neglecting Fundamental Analysis

Momentum investors typically eschew in-depth analyses of the fundamental or intrinsic value of their chosen assets. Their decisions hinge solely on identifying and riding strong price trends, whether upward or downward. Critics argue that this lack of attention to actual asset value may contribute to unsustainable price movements, posing risks for investors who may incur heavy losses if they sell late when prices align with intrinsic values.

Combining Forces

Some investors opt for a dual approach, combining value investing focused on assessing intrinsic value with momentum investing. This strategy aims to leverage existing price trends to enhance returns while considering the fundamental worth of assets. Traditional value investors emphasize purchasing undervalued assets and selling them when prices align with intrinsic values, even if this process takes several years. By blending value and momentum strategies, investors aim to identify undervalued assets precisely when their prices begin trending toward intrinsic value, avoiding prolonged investments in stagnant assets and potentially unlocking higher returns.

4. Unveiling Momentum in Passive Index Investing

Advocacy for Index Funds

Momentum investors contend that passive investing strategies advocating for index funds tied to benchmarks like the Dow Jones and the S&P 500 are inherently grounded in momentum principles. Renowned value investors, including Warren Buffett, recommend retail investors to opt for index funds mirroring these benchmarks, asserting that they comprise high-quality companies demonstrating consistent earnings growth. However, it's essential to note that the construction of these indices relies on market capitalization rather than the actual earnings of companies. For instance, India's Nifty 50 consists of stocks whose prices have consistently risen, propelling them into the top 50 companies by market capitalization.

The Essence of Momentum Investing

Momentum investors employ diverse methods to assess an asset's price momentum. A straightforward approach involves buying assets with the highest percentage gains over the past three to six months while selling those with the most substantial percentage losses. Another metric involves evaluating an asset's price performance relative to benchmark indices. More sophisticated momentum investors delve into the price charts of assets, attempting to gauge the strength of the upward or downward trends.

Dynamics of Price Movements

It's important to acknowledge that the price of an asset doesn't always follow a clear trend; it might move sideways. During such periods, momentum investors may choose to stay on the sidelines, holding cash until more discernible trends emerge. This flexibility is inherent in the momentum approach, allowing investors to adapt their strategies based on the prevailing market conditions.

5. The Way Forward

Momentum investing offers a distinct approach, challenging traditional wisdom and potentially delivering high returns. However, it's crucial to acknowledge the potential risks and understand the diverse methods used to navigate the ever-changing tides of the market.

Source: The Hindu