For equity investors, the momentum style of investing has been the most dominating theme in the past two years. As the market rally was not broad based, plenty of opportunities surfaced on the momentum side which benefited the investors. Momentum strategy considers the past price performance of the stock over a defined period.
It is a rule-based investing system that buys and sells stocks based on the past returns. Investors purchase stocks that have performed relatively well in a period of time and avoid stocks that have underperformed over a defined period. Anand Vardarajan, business head, Banking, Alternate Products & Product Strategy, Tata Asset Management, says usually, momentum as a theme does well in an upward trending market. “For the last couple of years this has been the trend and not surprisingly, momentum is doing well,” he says.
What to consider
Investors must note that momentum investing is not a ‘buy and hold for a long term’ kind of strategy. Stocks will have to be sold once momentum is lost and investors must keep in mind that there is no one single method to identify momentum stocks. Harish Menon, co-founder & head, Investments and Product Research, House of Alpha, says the composition of momentum index will witness a lot of churn. “Investors must be prepared for this kind of change in holdings which will result in increase in transaction costs. Another point that investors must keep in mind is that this strategy does not work well in volatile market conditions.
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Also, if the market is going through time correction where prices are more or less stagnant, momentum investing strategy may not perform well,” he says.
Momentum strategy is good for seasoned and experienced investors, especially with an experienced fund manager executing this. Santosh Joseph, CEO and Founder, Refolio Investments, says it is better if it is done with a little bit of experience and with a measured exposure. “Getting attracted to momentum investing because of the ability to turn around a portfolio quicker or make a quicker buck comes with its own share of risks,” he says.
How to invest
As buying and selling each stock individually while keeping overall index weights intact will be difficult for most retail investors, they should look at momentum stocks through the exchange traded funds of the stock exchanges. Alternatively, they can look at momentum funds of asset management companies. Last month, Tata Mutual Fund came out with Tata Nifty Midcap 150 Momentum 50 fund, a midcap index with momentum as a filter. Individuals with a long term horizon may invest in this open-ended scheme without trying to pick stocks by themselves.
Look out for the risks
Momentum investing can give high returns but is fraught with high risk. When the trend breaks, analysts love to bash high-momentum stocks for high valuations. These risks can be mitigated by diversification, having a strong stop-loss and de-allocation policy, dynamically adapting to market scenarios. Sonam Srivastava, founder, Wright Research, a SEBI registered investment advisor, says there is a recurring doubt among investors that momentum might not be a strategy suited for the long-term as it tries to capture short-term trends. “But if you look at the data, you will find that momentum is, in fact, an excellent strategy for the long term,” she says.
While a momentum investor is looking at technical signals, Srivastava says the horizon of these signals can be distinctly large when betting for the long-term. “And momentum can prove to be an excellent strategy for the long term as it will give you distinctly high performance during bull markets,” she says.