Does momentum investing really work ? Can it outperform benchmarks consistently ? I have my doubts, but I have tried to be open minded & revisit the idea. 2nd Jan, 2018, I have created a equal weighted, Hot Stocks portfolio with a strict trailing stop loss and tracking the performance. Retain the winners and cut the losers. This is an experiment, albeit sincere one. However I have allocated a very small fraction of my savings.Its not at all a recommendation and only a learning experiment.
Price Momentum by definition is rapid price acceleration with volume increase and is expected to continue until and unless adverse force acts on it. In a way it clearly aggravates asset mis-pricing and cares very little for valuation and quality of business. Actually momentum creates opportunities for value investors as price sharply deviates from value. Momentum sooner or later faces reversals & crash, called momentum crash !
Hi Anupam,
How did you select which stocks and what is your stop loss criteria?
Also, wouldnât it be better to track performance against a benchmark to evaluate? Looking at your portfolio it could be BSE small cap for instance?
If by momentum investing you mean trend following, then we have to get in early/ at the beginning of uptrend and stay invested as positive momentum builds upâŚor exit if it fizzles out.
Thus whether or not momentum investing works depends upon your entry price and your exit strategy
As far as I understand & read⌠short term(1W, 1M, 3M,6M) & very long term(2Y,3Y,5Y) show reversal tendency, whereas intermediate momentum(6M to 12 M)shows continuation tendency.
However what you meant , if I understand correctly is we should prefer fresh momentum & not stale momentum. That is momentum which will carry forward for a longer time. I would love to get more knowledge as to how to identify which patterns have longer continuation and lesser reversal.
The problem with momentum is always whipsaws. In a secular trending market, momentum will in general outperform, and that too handsomely. But in a sideways/bear market you run a chance of so many whipsaws that it can ruin all your profits and portfolio. (Depending on your rules it can happen in a bull market too, of course)
i think the your basic premise of selecting stocks and SL is extremely flawed. What you are calling momentum investing is breakout trading and has great success ratio. This is technicals based trading and if you dont know technicals you are bound to loose heavily. I vouch for trading and if done properly can make big money in it. Multibagger money i mean.
YesâŚquite aptly put. Momentum investing is mostly based on Technical Analysis and in a bull market momentum beats all other strategies. Afterall,thats the definition of bull market.
And in bear market, obviously momentum does not work
1.Top gainers last 6-12 months
2. From 1, filter and select smooth, consistent charts.
3. Avoid micro caps
4. Strict TSL of the 15%
5. Quarterly rebalance
I am assuming most of these will rise further due to momentum, and eventually bend down. I will book profit in the process. e.gâŚRise from 100 to 160 then stopped out at 136. 36% gain.
Whipsaws - no specific strategy. Hope TSL of 15% takes care.
Sideways-Market correction- stock specific approach. Anytime high momentum stocks would be available
Drawdown-Crash - continue search for momentum. If FD has better rise than overall equity then that becomes a natural selection as per method.
I am not sure if this is a named strategy but letâs see how it works.
people who know technicals, already know the result of your little experiment. rather than doing âexperimentâ for your own sake its better to invest time in learning technicals and am sure it would be profitable also. anyways, its your time and your money and you are obviously free to make your own choice sir. Good Luck.
Lets put this thing you have begun in the right perspective.
You are calling it Momentum investing. This means that there has to be a definition of momentum as the very basis of stock selection. From you rules it appears you are stating that top gainers in 6-12 months is the definition of momentum. This is a debatable and questionable. 6-12 months is a wide band. Where do you fix it? Next, select smooth and consistent charts from the shortlist. What is the definition of smooth or consistent? Is that supposed to mean non-volatile? If so, do we have some sort of criterion for that? Third, avoid microcaps. No problems there. A universe can be set that doesnât include microcaps. Fourth, a trailing stoploss of 15%. How is this arrived at? Why not some other number? Does it take into account the volatility of individual stocks or that of a portfolio of such stocks? Is it too much or is it not enough? Is there any criteria to decide that? More money has been lost because of wrong stop setting than any other reason. Where is the provision for probability of success? Is the top gainer reading supposed to take care of that? Or perhaps the smoothness of the chart will do the trick? Momentum investing succeeds when the probabilities are high and not when just risk is defined. Finally, quarterly balancing. If you are dealing with momentum, then there is no specific time element attached to that. It shows up suddenly and fizzles out as suddenly. Are you interfering with the performance by enforcing a quarterly rebalance?
As we can see, a number of question marks in the design. Not trying to criticise. But just pointing out some flaws in the approach, which if addressed, you may end up closer to your objective.
For the record, I am practicing Momentum Investing (only) using Technicals as the mainstay and vetting stock selection thru fundamentals as well. Trying to run a momentum portfolio without knowing technicals would be like batting with one arm strapped to your back. On an average it yields me 30-35% consistently. The only losing year since 2010 was in 2011 with 2016 as a scratch year. No rocket science. And quite doable too, in my opinion.
Thanks. Food for thought. Will think over it in detailsâŚseems from quite a few replies, technical know-how is a must for MI.
Meanwhile let me answer to your queries.
1. I select top gainers 1 year.** Few of them also feature in top gainer 6 months as well. This is intermediate look back period. As per research short look back and long look back, both have reversal tendency. Intermediate look back has continuation tendency. Please note its tendency and not guarantee. Probability to be precise.
2. Identify Smooth chart - plain visual inspection. Then higher % of daily positives. Then calculate R^2 in excel.
3. Smoother charts have been proven to run longer without mean reversion - limited attention hypothesis. Small monthly dose of good news builds up instead of Big Bang announcement like RCom RJio partnership or Vishal Sikka exit.
4. Trailing Stop loss % - back test with 10, 15, 20 %. I found higher the better. But I am Bit loss averse so chosen 15%. Just good enough to avoid whipsaw but exit in a deeper correction. Open to enter when the stock regains momentum. No affection or dejection - but rule based.
5. What I found most difficult till now is not the above 4 points. Itâs easy and my wife does it. I am not able to figure out a scientific method to differentiate between a whipsaw effects. Correction and drawdown crash. How to know that momentum is slowing - stock specific and portfolio level and maybe benchmark index level. That would enable absolute momentum. That is moving out from equity and parking in FD and again enteringâŚkind of rotational ETF momentum strategyâŚ
Nevertheless, keep your inputs coming. I take every input and criticism in right spirit
Seeing your post after a long gap. As always very enlightening.
Would you be able to throw more clarity on any specific criterion you use to judge the fundamentals? And ofcourse any measurable ways by which you identify momentum would help as well in terms of information. As i understand you have had a long history of techno funda success. Eager to know more with an open mind.
My approach to looking at fundamentals does not vary much from the standard ways that most of us look at it. I am not skilled enough to go into the depths that various members do here. I satisfy myself on the main criteria of management, earnings, growth, returns and transparency and consistency. More than anything I look for strong growth in sales and earnings as market fancies this the most while pricing the stock. My approach therefore does not search for diamonds in the rough. I am happy to get into a stock after the turnaround happens.
If there is one yardstick that I apply to news and events (that create the fundamental environment for the market players), it is to look at market reception to that news or event rather than the news element by itself. It is impossible for anyone to know the extent to which a news element has already got exposed to the market before we come to know of the same. It would be particularly foolish to think that we are privy to any information ahead of the market. Hence I prefer to look at the market reaction to judge whether or not that piece of news is already into the price. This is not a spur of the moment judgement but a more sustained observation thru a few sessions.
At times like these having a sound technical knowledge comes in very handy, because that is the way to track the market response. Technicals, after all, speak the âlanguageâ of the market and we should pay attention to what the market says about itself. Understanding market response to news and events helps me to arrive at possibilities that can ensue and evolve. After that it is a matter of setting up the technical parameters in a manner where the trend can be tracked from a suitable distance. How far away, will really vary from stock to stock and that is where skill at the subject will really come in.
It doesnât matter whether the stock is HEG with 1400% return for the year or TTK prestige with 62% return. They all can be tracked. Big moving stocks have a âstoryâ behind them- like HEG had rising graphite prices and China as the main story. Similarly, one has to build a âtechnical storyâ for the stock, using the right set of parameters. It is not difficult once you know how.
One of the truths I have learnt thru the past several decades in the market is that at market extremes, technical and fundamental analysis will diverge from one another whereas they come together to act in unison during the mid phase of the movement. Being able to identify the variance between TA and FA set ups can even help one identify major trend changes and catch changes early at market extremes. During mid phases of trends, it is quite easy to deploy a fusion of TA and FA but at extremes, one has to turn a purist of sorts even as you keep the facets of the other form in mind.
Defining momentum requires multiple lessons and may be difficult here. Also, it may not have many takers, given the leanings of this forum. Hence I have highlighted the approach rather than its details. Most definitely a good understanding of technical is essential if one has to attempt momentum investing. Ultimatley, fundamentals of a stock gets reflected in its price thru time. A devout study of prices will help one understand how well the known fundamentals are playing out currently and how much of unknown fundamentals are influencing the price moves. Understanding and deciphering that would be one of the keys to success in the market.
As always - one learns something new after reading your views. Your observation about TA and FA divergence at various points is interesting and insightful. Thanks once again and do keep sharing! Views of seasoned practitioners like yourself that have gone through many cycles of the market certainly add value though one may not necessarily practice them as well as you do.
Very important point you have highlighted here about market reaction to news or results.
I found that useful while following the pharma sector. Inspite of stellar results posted by both torrent pharma and alembic pharma both of which I owned, (mainly because of the one off opportunity of aripiprazole) the stock prices failed to register fresh highs and that made me start thinking that something was wrong and I was maybe looking at things with a wrong perspective. Coupled with that the persistent weakness in market leaders like Sun pharma and Lupin prompted me to exit pharma sector completely. Even though both torrent and alembic have not corrected to the extent of other leaders like sun/lupin/glenmark etc but still there could have been a different outcome if any or both of the companies were found wanting during FDA inspections.
Contrary to the above example sometimes inspite of extremely poor results or extremely negative newsflow, the stock doesnt correct or what is more pertinent doesnt break the earlier swing low. That to me is very important to notice and keep following for a few trading sessions in an effort to judge if there is an opportunity to buy. I saw that thing happening in Satin (MFI Co) where stock went down quickly but the earlier low was not violated. That told me that market has factored in the worst for the stock and the next direction is probably up. But I didnt have the courage to buy the company. But once we keep observing these things then it tends to sharpen our technical analysis and often helps in unearthing good opportunities.
Hi Anupam,
Good to know of your analysis.
As mentioned by other members technicals is used for Momentum investing and there are few screeners that will help identify shortlist potential candidates which you can use for breakout strategy.
Top gainers last 6-12 months:
12 months is too long. 20 - 30 weeks might be a better choice.
From 1, filter and select smooth, consistent charts.
Instead of filtering for smooth charts, select companies with good fundamentals and low pe. Charts of the past have no relation to how they will look in the future.
Avoid micro caps
Just the opposite. Your strategy has a strict stop loss, and micro caps have more growth potential. If anything look at avoiding large caps.
Strict TSL of 15%
This is too low. You are buying companies that have gone up by 40-50% in the last few weeks. Most of them will have pullbacks. Also, try to limit your risk per trade to 1-2%. Position sizing can be complex but 20 max positions with equals allocations and 30% fixed trailing SL works well most of the time(1.5% risk per trade).
Quarterly rebalance
Isnât this completely contradictory to a momentum strategy. With momentum, you will probably have around 40% success rate and most of your money will be made by big wins. Rebalancing will severely deteriorate your overall returns.
Couple of ideas:
Look at a relative index overlay. Something that give you a big picture of the overall market conditions. Simple example of this is a 100 week moving average of the underlying index(NIFTY or JNF). Avoid buying when NIFTY is trading below its 100 day MA. This will make sure that your portfolio doesnt lose half its value when the the market crashes. In my backtests, this has been much more important than my entry/exit criterias.
Stop loss. When the relative index is green, keep your SL at 30%. When the relative index turns red. Move your SL to 10%. This will make sure you exit your positions quickly when the market starts to crash.
Dont look at booking profits. Dont assume anything. Just allow your stop loss to take you out of the trades. Momentum works when you let your system do the work instead of tweaking things on your own.
