Types of Momentum Investing
Momentum investing resonates with the prominent proverb – ‘cut your losses and let your profits run.’
Momentum strategy aims at buying high and selling even higher. This makes momentum investing counter-intuitive to all other investment strategies. Instead of selling their top-performing stocks, investors increase stake in them and exit their worst-performing stocks without waiting for a bounce back. It resonates with the prominent proverb – ‘cut your losses and let your profits run.’ Ergo, momentum investing is the opposite of value investing.
To quote renowned finance blogger Ben Carlson, “Value investing is based on a long-term reversion to the mean. Momentum investing is based on that gap in time that exists before mean reversion occurs. Value is a long game, while momentum is usually seen in the short- to intermediate-term.”
Types of Momentum Investing
There are two types of momentum investing:
- Relative Momentum: As the name suggests, in this strategy we compare the historical performance of a stock to its peers and then shortlist the stocks which have outperformed their peers. Investors then invest in these stocks hoping that they will outperform in the near future as well.
- Absolute Momentum: In this strategy we compare the recent performance of a stock with its own historical performance. Investors then take long positions in positive performing stocks and short-sell negative performing stocks.
In a nutshell, relative momentum measures how a particular financial security has performed in relation to other securities and absolute momentum examines whether a particular investment has actually risen in value over the past periods.