What is momentum investing? And is this strategy better than value investing? Explainer

Investment advisors and experts often point out that investors should buy stocks at a lower price and later sell them at a higher price to make a profit. It is also not considered wise to buy or sell in a panic when stock prices are rising into overvalued territory.

They are told to stay away from irrational excitement and spreading panic.

Momentum investing, on the other hand, follows a different strategy and encourages investors to invest when stocks are rising and sell them when they have already peaked or started to fall.

Here we will explain the concept in detail.

What is momentum investing?

This is an investment principle that encourages investors to ride the waves of the market rather than making contrarian bets. Based on this, investors invest when stocks are rising and sell when they are falling.

The rationale behind this is the assumption that the market will continue on its current trajectory, at least for the time being, and the trend will not reverse.

This investment principle was popularized by Richard Driehaus, also known as the father of momentum investing. According to him, you can make much more money by buying high and selling at an even higher price instead of looking for undervalued securities.

Important points to remember:

1. The principle involves buying stocks that are rising and selling them even higher when they reach their peak or start falling.

2. The rationale behind this principle is that in the short run, the market trajectory is constant, with rising stocks rising for some time and falling stocks continuing to fall.

3. This principle was made famous by Richard Driehaus, who argued that investors should focus on buying high and selling even higher, rather than looking for undervalued stocks.

4. This strategy is applicable in the short term and requires regular monitoring of stock prices.

Let’s understand this using a diagram.

Suppose Mr. X has. INRYou invest $5,000 in company “A” whose stock price is increasing. Let’s assume that stock ‘A’ is trading at the following price: INR100 and is already up 10 percent in the past month. Therefore, X will be able to buy his 50 shares. INRSince these stocks are on an upward trajectory, you can earn $100 each and profit later.

You can then sell when the price peaks. INR120 or after that it starts to go down.

Suppose two months later, the stock price starts to decline. INR120 and the price within a week has already been reached INR115; Next, according to investment momentum, X should sell his 50 shares for $1. INR5,750 (115 x 50).

In the diagram above, X has executed two trades. One buys stocks when they are rising, and the other sells them when they are falling.At the end of these two of his transactions, he became even richer INR750 (5,750 to 5,000).

All he had to do was buy stocks that were rising and sell stocks that were falling.