What is “momentum investing”?

Momentum investing focuses on growth in the stock price: a momentum investor buys stocks that have gone up the most in the recent past, or are making new 52-week highs, and avoids or even sells those that have done badly. Nowadays, many people invest in some Tech companies like Apple, Google and Amazon because of their “momentum”. As they are prospering, they are constantly on the news, with their prices breaking records all the time. In these cases, “momentum investors” try to profit on their bullish trend, in the hope it will continue for a long time.

Momentum investing and growth investing are frequently confused with one another. However, while they have some similarities, they are two distinct strategies. Growth investing focuses on buying companies that either have strong recent earnings growth, or are expected to have in the future. But, they might not be yet in their best shape. Meaning the investor bets on their rise from “insignificance in the market” or from their recovery from bad days.

Moving back to momentum investing, some people see momentum investing as just something that had success in a seemingly random event, it is more likely to succeed in the future.

The approach has also been blamed for encouraging stock market bubbles, as investors buy into rising shares in order to get ahead of future price rises. For example, the 1990s technology boom saw the number of momentum-based funds soar.

Amazon stock last 5 years
Amazon stock last 5 years

These funds did very badly when the bull market came to an end in 2000. Despite this, several studies suggest that the stock market does indeed exhibit positive short-term momentum – in other words, stocks that have gone up just keep going up – and that as a result, performance-chasing strategies can work.

However, other studies show that over extended periods of time the momentum effect disappears, and that it’s the shares that have seen the greatest declines that are more likely to outperform (which is why many back “value investing” for the long run). Momentum investing can also involve a great deal of trading, which raises costs and eats into returns.

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