Online Stock Trading

What it are momentum stocks?

Momentum investing is the most difficult to define of all the common trading strategies, but simply put, it’s based on looking for companies whose stocks have been getting stronger over the past 3 months to a year. The rule here is “buy high, sell higher.”

Why people choose momentum investing

Investing in momentum stocks is simply a proven-effective strategy. The two people credited with defining momentum investing, Narasimhan Jegadeesh and Sheridan Titman, showed this strategy yields average returns of 1% per month for the 3 to12 months following a given trigger event that signals when to buy the stock. Their first report was published in 1993 by the American Finance Association and another report that confirmed their earlier research was published in the Journal of Finance

The benefits of trading momentum stocks

The first is profitability. Statistics show trading momentum stocks is a sound and profitable strategy provided you do your research and watch your timing.

Another advantage for some is that the system doesn′t require absolute accuracy when picking stocks. Instead, momentum investors look for large reward to risk ratios. For each stock that loses a small amount, they find at least one if not several that brings in a 50% or higher profit.

Relative simplicity is another benefit of this strategy. Most trading systems require an enormous amount of self-discipline, which many people just don′t have. The system of trading momentum stocks is based completely on concrete data that’s easy to find, so your emotions won′t take you off course.

Although many people presume the turnover in this strategy would be extremely high, but in most cases it really isn′t particularly bad. Average turnover seems to be around 90% and while high, it’s still lower than with certain other strategies.

The downsides of trading momentum stocks

Momentum investors don′t buy stocks to hold. The stocks they buy are highly volatile and while the investors expect their momentum stocks to do well in the short term, they’re ready to sell as soon as the stock starts going downhill. That means if you don′t get your timing right, you won′t profit much.

Another complaint against the momentum trading is that economists can′t seem to figure out exactly how this strategy works, which makes it seem like it’s based on nothing but dumb luck. Some economists believe it works because the high returns offset the risk, while others think it’s a case of smart investors taking advantage of the mistakes of other investors, such as overreaction to hot stocks.

Trading momentum stocks is a sound strategy that, while riskier than some, can provide excellent returns for those who know how to identify momentum stock accurately and can get their timing right.

Of course, that may be just the reason why you shouldn’t get involved. Momentum traders find stocks that are on an upward or a downward swing when they invest in the company. They make money by buying low and selling high or by buying high and selling higher. But as with any kind of investing, there are no guarantees.

Momentum traders must do a lot of work to gather their information.
They must read business papers and the online news sites to see which companies are creating the most buzz. The companies that are releasing new products or that must hold a news conference to explain a product failure are going to be of particular interest because they have the greatest possibility of a momentum run.

As a momentum trader you will need to closely follow corporate earning releases and pay attention to what the business forecasters are predicting. In short, it can be a pretty time consuming endeavour. The good news is that as a momentum trader, you aren’t just looking for companies whose stock is doing well. A company whose stock is about to nosedive is perfectly suitable for your purposes.

Once you have narrowed down your selection of stocks your research is not over. You now have to take the time to analyze the stock’s EPS earning per share) also known as accelerated earnings. Seeing how well a stock did over the past three quarters is an excellent barometer of what the stock’s potential is. You will have to check out the morning equity options pages to determine if there have been an excessive number of written calls out on the company you are researching because the higher number of calls can indicate whether a stock price increase or decrease is anticipated to occur.

You are looking to find a breakout stock so the initial morning trading must be watched very closely to see if there is one stock that stands out. Watch the current bid/ask price and the total daily volumes. If you can identify a stock then it is time to buy. Now this is the most difficult part of momentum trading. You are now going to ride the momentum train and although it can be very exhilarating, it is not for the feint of heart.

Once you have clicked the buy option, you simply have to watch and wait to see how the stock does. Will the momentum continue or will the stock just fizzle out? That is something that happens to the best of momentum traders. Sometimes you pick a dud and the best thing to do is cut your losses and get out.

Do you have nerves of steel? Do you have plenty of time to spend reading the business news, Wall Street Journal and a plethora of other sources from the Internet? There is the potential to make a great deal of money with momentum trading, but you must know and understand yourself before deciding to jump into the fray.