Momentum investing or momentum trading is a common strategy used among investors and traders who take advantage of swings created from market volatility. This strategy consists of a “buy low, sell high” mindset to make a considerable profit. However, this simple statement is much harder in practice, especially when an investor’s emotions are tied into the mix.
Unsurprisingly, most investors fail to recognize when momentum is just beginning and when it has begun to taper off. Luckily for us, there are many ways to minimize a realized loss from occurring while using a momentum-based trading strategy.
Jumping straight into momentum investing without instructions can create brutal wounds in a portfolio. So, it’s best to follow a strict set of principles that investors abide by in times of market volatility.
For one, picking equities can be daunting. There are an incredible amount of stocks to choose from, but only a handful truly contain the opportunity which an investor seeks. In this case, stock screeners can be immensely useful to filter out stocks that are sliding to new 52-week lows. Ideally, investors should look for stocks with positive news that are reaching new 52-week highs, often a critical sign of short-term momentum.
Secondly, the timing of these trades can be the difference between profits and losses. For instance, if the stock has produced a considerable amount of gains during a specific trading period, it may be wise to wait for a slight temporary pullback to purchase shares. This way, investors aren’t bidding the stock higher, but entering after a decline, catching the momentum once again.
Lastly, exiting the trade. It can be tempting to hold over a long period of time, but what goes up must eventually come back down. In this case, and especially in this current market, it can be unpredictable and riskier the longer a short-term position is held if traders have already generated a significant amount of profit.
While momentum investing or trading can be appealing to a large portion of investors and traders in the markets today, only some can abide by the important principles to generate recurring profits over their investment journey.