Momentum Investing

Have you ever watched a heavy freight train hurtling forward at full speed? Once a massive train gets moving fast, hitting the brakes will not stop it instantly; it keeps rolling forward for a long distance. In physics, this tendency of a moving object to keep going is called 'momentum.' The greater the momentum, the harder it is to stop.

Something very similar happens in the stock market. When a stock's price surges, it catches investors' attention. As more money pours in, the price is often pushed even higher for a time. Momentum investing focuses on this behavior by choosing to buy assets riding an upward wave.

Traders often say, 'Buy at the knees and sell at the shoulders.' Instead of trying to guess the exact bottom, momentum investors wait until a stock moves past the knees toward the waist—confirming a solid uptrend—before jumping in to take profits near the shoulders. Keep in mind, though, that this is simply an average statistical tendency across many assets, not an unbreakable law of physics.

Warren Buffett's famous 'value investing' is like bargain hunting at a luxury store during a blowout sale. You buy stocks priced lower than their true intrinsic value and wait patiently. The goal is to analyze business fundamentals and 'buy low, sell high.'

In contrast, momentum investing does not worry much about whether a company is cheap or expensive relative to its fundamentals. Instead, it prioritizes market popularity and price trends. In short, the goal is to buy high and sell even higher.

Because of this, momentum investors focus less on financial statements and more on price charts, trading volume, and moving averages. A classic approach is to build a portfolio of the hottest-performing stocks over the past three to six months.

Riding a powerful surge is exciting, but it comes with serious risks. No matter how fast a train travels, it will eventually run out of fuel or slam on the brakes. The moment market enthusiasm cools, a sharp 'trend reversal' can send prices tumbling off a cliff.

That is why momentum strategies rely heavily on strict rules, such as regular portfolio rebalancing and risk controls. For example, investors establish stop-loss rules that trigger an automatic sale if a price drops below a set threshold. Still, market peaks are only obvious in hindsight, and even stop-loss orders cannot completely prevent losses during sudden market crashes.

To avoid getting swayed by emotions, many modern institutional investors rely on 'quantitative momentum'—using algorithmic rules to execute trades with machine-like discipline.