Momentum, Should You Put Your Money Into This Strategy?
I always thought of myself as a value investor, only investing with long term buy and hold strategy. Index investing is also part of the same play and is a passive strategy. This was the case until I came across the Momentum strategy.
What is Momentum Strategy?
Akin to the physics definition – momentum is the rate of change. It is the rate of change of a stock’s value. Richard Driehaus, the father of Momentum investing is credited with pioneering this. Though there are others as well.
Quoting this article on Capitalmind -“This idea is not new. It has been around for almost as long as organised investing has been around.”
In essence, Momentum strategy is about buying stocks that are going up. The other side of the strategy is to sell stocks that have peaked.
Did you just say Buy High?
This is one of the most non-conventional parts of this strategy. You buy a stock that has already appreciated. It does fly in the face of the value investing precept of buy low and sell high. In this strategy, you are buying high and selling higher.
The attempt is to buy stocks that are already making a move upwards.
In Richard’s original momentum strategy, he bought stocks with the highest returns in the previous 12 months. This usually meant, these stocks were at or near their 52-week highs.
Would you buy anything that is going up?
Within certain guardrails, this is true. You will look at stocks with liquidity and trading volume above a threshold. Other than that you are not really constrained by the quality of the company etc.
How often do you buy and sell?
This happens to be a downside of Momentum for those of us with a full-time job.
However, you can define your own frequency of change. Day traders churn their portfolios on a daily basis.
You could also look at this over a weekly / monthly/quarterly horizon. However, the longer the window between reviews, the higher your chance of missing a trend.
Is there a way to do Momentum passively?
The surprising answer to that question is ‘Yes’ There are two ways you could do this passively. The first is to buy a fund that invests in the Momentum strategy. There is a Momentum ETF, the UTI Nifty 200 Momentum 30 ETF. You can look up their performance here.
This ETF seems to have given better returns than the Sensex, however, they haven’t been around for long.
The other way to do this is via a PMS – this has a minimum entry criteria of 50 Lacs. If your appetite allows you to do this, then this would be an effective way to be passive.
What about associated costs?
Given the high volume of buy and sell for such an active strategy, there will be transaction costs and short term taxes. Since most of what you sell is likely to be within a few weeks /months of buying, the applicable tax would be 15%. So, you have to be convinced that this strategy will give you returns after deducting these costs.
Active mutual funds which follow this strategy have higher fee ratios. The UTI fund mentioned above has an expense ratio of 0.39% which is a pretty low one and makes it worth considering. PMSs will have associated costs, typically higher than MFs.
Is there a mid-path?
There are many services that will recommend Momentum stocks. The Capitalmind small case is one such. You could subscribe to this small case and implement their recommendations. This involves a small level of effort, buying and selling stocks once a week for a few minutes.
I believe there are many people following this strategy in the market.
This leads to two things:
1. There is slippage between recommended price and actual price. Multiple buy orders on the same stock will push the price up very quickly. It also works on the sell-side. Your net gains will always trail the ideal gains of the service.
2. The multiple Momentum strategies seem to do one more thing. Perpetuate Momentum. With more players playing the game, the game works even more. Of course this is true today, things can change.
Momentum is a strategy that departs from traditional Value Investing in the following ways:
1. Buy stocks of good companies and hold them for a very long time.
Momentum recommends buying any company (within guardrails) whose stock price is rising
2. Buy low, sell high
Momentum will recommend to buy high and sell when it plateaus in growth. This is contra to the traditional buy low philosophy. There are times you will buy a stock at it’s 52 week high.
3. High turnover has higher costs and is risky
Momentum by design will have higher turnover and does entail higher risk. However, the premise is that the market will continue to support the price direction. Of course high turnover does have transaction costs and tax implications.
4. Research your stocks and understand the business
This is obviously out. The Momentum strategy is only about price movement. You don’t need to understand the fundamentals of the company.
5. Have a systematic investment process based on the company’s value
The Momentum strategy requires you to be flexible. While there is a system in place, you will need to be ready to change based on the market.
In summary:
- The Momentum strategy is a departure from the more traditional long term investment precepts.
- It is a strategy that has given higher returns than market.
- As an investor, you need to be nimble to adopt a strategy that is working.
- There are different ways you could implement the Momentum strategy for yourself.
- You could choose across a spectrum of active to passive methods.
You can read more about momentum in these articles i. Investopedia ii. Zerodha University iii. Economic Times
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.
