Momentum investing: Identifying the best-performing stocks on the market

Author: Forex Live | Category: Education

Understanding momentum investing

IGM
The market world is filled with beautiful pyrotechnic pieces. That which shines the most is that which will attract our attention. The shares that will surprise us pleasantly with their unexpected price fluctuations are the ones that will take the reins on business sites and news networks. They are those which will boost the interest of investors. The largest one-day price movements are generally those that draw the attention of investors. 

But what other methods for assessing the strength of a price would be useful?

Price momentum over time

The momentum investing was first documented in a 1993 study by Narasimhan Jegadeesh and Sheridan Titman and to date continues to be studied by academics and implemented by professionals. 

Momentum investing usually consists of adhering to a strict set of rules based on technical indicators that dictate market entry/exit points for certain securities. It argues that trends can be sustained for a period of time and that it's possible to benefit by remaining on a trend until it is finished, no matter how long it may last. 

  • Momentum can be divided into two categories: investor overreaction and underreaction.

The overreaction emphasizes the idea that stock prices can deviate from their intrinsic values. An excessive reaction occurs when prices become excessively overestimated or oversold for psychological rather than fundamental reasons.

The underreaction emphasizes the idea that stock prices can drift to their intrinsic values. Underreaction generates momentum in stocks performance and post-earnings announcement drift, which leads to cost-effective exploitation of these anomalies.

Some high momentum stocks may be strong due to overreaction, others are driven by underreaction, while reflexivity is sometimes at play between the stock and the underlying business. When it comes to measuring stock momentum, it is important to note that not all momentum indicators are equal, while it tends to work better when used over periods of 3 to 12 months. The six-month dynamic of security equates to its performance over the last six months. Positive yield over time is described as positive momentum, while negative yield is known as negative momentum.

Traders can benefit from buying securities at a time of positive momentum or short sales at a time of negative momentum.

The frog's example

Wesley Gray, and Jack Vogel, have talked about the consistency of momentum in a distinct way. They used the example of a frog in a pan of boiling water. They claimed that if you put a frog into an already hot pot of water, it will jump out, but if you put a frog in the water at room temperature and slowly bring it to boil, the frog will accept its fate. 

Concluding that these stocks with a phased-in momentum receive less attention from investors compared to stocks that might show huge gains. As a result, investors are under-reacting to these stocks with a continuous or gradual momentum, which is an important factor that enables many of them to continue to produce solid returns.

Conclusion

It is obvious that no strategy is foolproof. None of the fireworks can guarantee our success. However, the ideal thing as a trader is to be able to strengthen your position and get the most out of a strategy. And maybe the most difficult part of the momentum investment is the ability of the investor to understand what drives the momentum in the first place.

Is your trading strategy strong enough to take up market challenges?

This article was written and submitted by IGM FX.

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Disclaimer: This material is considered a marketing communication and does not contain, and should not be construed as containing investing advice or a recommendation, or an offer of or solicitation for any transactions in financial instruments or a guarantee or a prediction of future performance. Past performance is not a guarantee of or prediction of future performance.
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