If you aren’t a practitioner of momentum investing, you might fall prey to the common misconception that it’s a de facto term for risky or aggressive. That’s far from the case. In fact, as part of a diverse actively managed portfolio, momentum investing can actually increase risk adjusted returns.
In the simplest terms, momentum is a style of investing that focuses on purchasing securities that are appreciating in price relative to peers in the broader market, and then selling those securities when they start to fall in price relative to peers. The fundamental concept is: that which goes up will continue to go up for a period, and that which goes down will continue to go down.
Over the past 20 years, momentum investing has gained academic backing on par with more widely recognized strategies such as small-cap and value investing. So why do so many still believe it is inherently risky? The answer comes down to the way it is sometimes practiced regrettably with more focus on the upswing than the downswing.
If you practice momentum investing, you should have a healthy respect for market activity, up or down. During the tech boom of the late 1990s, many momentum investors did very well riding the upswing. Not as many successfully negotiated the volatility of those stocks on the way down. There were spectacular failures. That may have soured people on momentum investing, but the problem was less in philosophy than in practice.
I see momentum investing as a continual process of trying to uncover and admit to your inevitable mistakes as a money manager. In that sense, it isn’t inherently risky, but inherently humble. Momentum forces you to continually reappraise your original purchase, and to focus not on what has happened, but what could happen. When a stock starts to decline relative to its peers, that’s a yellow flag. An active, disciplined and prudent momentum investor will treat it as such.
Properly practiced, then, momentum won’t get you into a beaten-down stock at the bottom, and it won’t get you out of a roaring name at the top. Instead, it helps you catch a lot of middles. And when you think about investing, it isn’t about getting the grand slams; it’s about avoiding the devastating strikeouts.
By NORMAN CONLEY III Article from wall street journal
Mr. Conley is chief executive and chief investment officer of JAG Capital Management in St. Louis. Email him at email@example.com