Momentum Investing and Trend Following: The Secret to Significant Portfolio Returns

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Two popular terms which regularly confuse investors are "trend following" and "momentum investing." Perhaps the foremost glaring commonality between these two is their blatant defiance of "buy and hold," the practice of choosing an investment and holding it indefinitely, believing that over time the market goes up, and so any investment will appreciate. Although the buy and hold approach has been touted for years by academics because the best method of investing, actually it's its shortcomings, which are apparent in every market.

Despite being the antithesis of buy and hold, both momentum investing and trend following strategies are predicated upon a disciplined investment approach that's designed to shop for when the value of a problem is increasing and sell when the value is declining. Additionally, an exit strategy is generally incorporated to override the human tendency to carry losing positions much too long. Yet despite the distinct characteristics that these two terms share, actually they're quite different.

What is Trend Following?

Trend following, in its most elementary definition, could be a systematic investment approach predicated upon buying and selling securities supported the sustained price movement of the problem. it is important to imply that trend followers don't predict the longer term price movement of a stock; rather they examine the problem using technical analysis to work out which direction, if any, the equity is currently moving. If a bullish trend is emerging, the trend follower will likely buy a footing within the stock and hold it until the trend begins to weaken or change direction. If the equity exhibits a bearish trend, the trend follower can short the position, wait until the trend reverses, or merely find another issue.

But there's far more to being a successful trend follower than simply selecting and buying securities. In fact, it are often argued that the foremost important aspect of trend following isn't when and what to shop for, but rather when and what to sell! Often times, successful trend followers establish a "sell rule" that has got to be violated before selling the problem. These sell rules vary counting on the danger tolerance of every investor, but they typically encompass a trailing stop loss let alone a confirming indicator. The overarching advantage of sell rules is that they supply a disciplined, mechanical methodology which the common investor should seriously consider implementing into his investment philosophy.

What is Momentum Investing?

Momentum investors are constantly looking for companies that are moving faster than the market. They believe substantial returns are often realized if they find, buy and hold onto those issues for as long because the price continues to travel up. The old axiom, "if it is not broken, don't fix it" illustrates the shared philosophy of momentum investors; those companies with the largest price changes over the previous couple of months are more likely to continue making substantial gains.

Fundamental analysis plays a way bigger role in momentum investing than it does in trend following. Momentum investors believe that buried within a company's earnings statement is that the reason why the value has been increasing so dramatically. And if that underlying reason is uncovered, the chance presents itself to exploit that knowledge within the future.

In the case of trend following, investors want to spot where a security is also within the performance cycle. for instance, how near the 52-week high or low is that the current market value and what's the short-term direction of the issue? For the momentum investor, the key criteria is also the relative strength of the protection versus the market or more importantly the contemporaries of the actual security in question.

Read Also : What Is Value Investing?

How to Develop a Successful Investment Strategy

Investors often ask why undergo all the hassle of actively managing a portfolio. the easy answer lies within the proven behaviors of economic cycles and sector rotation. Independent studies have proven that over time the most important percentage of a securities' price appreciation is driven by the commercial group within which the corporate is classed and not the performance of the individual company itself.

However, the $64000 reason why investors should actively manage their portfolios could be a concept called the "Time Value of cash," also called "Compounding Rate of Growth." Many financial professionals will use the instance of how a penny, if doubled daily, is worth over $10 million after only 30 days. a awfully impressive and eye opening number given the tiny amount of initial capital outlay. What would happen if rather than doubling the penny daily, it were to grow by only 75%? The investment would be worth slightly over $195,000 instead of $10.7 million. Reducing the expansion rate further to 50% and also the end value is now $1,917.51. A 25% rate of growth for 30 days produces a worth of only $8.08.

How does the concept of compounding growth translate into the choice of an investment strategy? Investors who actively manage their portfolios, either through trend following or momentum investing, have the power to require modest gains and re-invest the profit in other trending securities over and another time. Buy and hold investors aren't awarded this luxury since they rarely sell when the value is at the highest. Rather, they buy a footing when the value is low, ride the position all the far during a securities industry, then watch as is loses value during a market. it is a very frustrating strategy, equally hard on the stomach because it is on the wallet.

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