The momentum stock trading strategy for investing in the stock market can be quite successful in a raging 'bull' market or in stock market booms where prices of stocks are rising across the board ... providing you manage to sell in time.
Why Avoid This Strategy? If I had no reason to buy the stock in the first place other than that its price was rising, then I am gambling (or speculating if you like).
Hence it is difficult to know when to get out, other than if I am finding it hard to sleep at night.
I would be gambling that the stock momentum will continue, but would have no means of knowing how far. A sell decision then becomes difficult to make.
It is even more painful if you sell too early and the stock keeps rising!
GREED IS A STRANGE ANIMAL!
As a result, I do not consider this to be a good investment strategy - and not one for picking good stocks for the longer term.
A crafty version of momentum investing - one that I tried in the past when searching for a winning strategy - is to buy into rising stocks, that is good momentum stock picks, while limiting greed.
I used to place a 25% profit cap on each stock and disciplined myself to sell when that profit level was reached.
The (gambling) rationale was that stocks tend to rise with the overall stock market over time. Stock market fund managers love to show graphs of how the stock market index has risen continually over the last 100-odd years.
The downside is, market reversals look smaller over longer periods of time!
The problem with my strategy was that while some stocks hit the 25% jackpot quickly and gave me an annualized profit of much more than 25%, which suggested that momentum investing was a good short term investing strategy, others took up to five years to do so.
Of course, 25% over five years equates to 5% per year, a not so great return on equity, considering the risk.
A further problem was that other stocks did not continue to rise over time but went down hill. But I had a strategy for that eventuality. I put a 20% loss limit on those and wrote off 40% of the loss on tax to minimize the pain.
When there was a general downturn in the market, most of my momentum stocks gained momentum in the wrong direction and my previous profits disappeared.
Not very smart investing!
Momentum stock trading, whatever the limits placed on greed, works best in 'bull' markets and performs miserably in 'bear' markets when the overall price trend of stocks is down.
Compared to value investing where there is a reason to purchase based on the intrinsic value of the stock, and a reason to sell based on overvaluation, momentum investing relies on pure hope, hope that the market continues to rise.
I can avoid using momentum stock trading when I choose stock based on value investing principles.
But it is amazing how commonly some investors base their investing on stock momentum!
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