Excessive momentum is exhibited available in the market when the worth advances or declines over a variety in a brief time period.

Momentum investing is a method which is constructed on the easy assumption that monetary property corresponding to shares, indices, derivatives, bonds, commodities which are exhibiting energy will proceed to go up no less than within the quick time period, so we purchase these these securities whereas promoting these property which are exhibiting low returns. Thus, having a portfolio of such property ought to provide higher returns than that of the broader market return. Allow us to focus on the identical intimately.

Mechanics behind momentum investing
This funding technique isn’t new. The mechanics behind this technique relies on the funding philosophy of reducing your losses and letting your winners experience. In different phrases, the idea of momentum investing states that short-term efficiency is repeated with winners persevering with to be winners and losers persevering with to be the losers. It’s purely primarily based when worth motion momentum is excessive. Excessive momentum is exhibited available in the market when the worth advances or declines over a variety in a brief time period.

Reason for momentum impact
In accordance with behavioural finance literature, buyers usually overreact or underreact to data which ends up in worth adjustments and thus result in worth inefficiencies. One other believable purpose might be the market timing. As an example, buyers could react very slowly in response to new data concerning a inventory after which realise the significance and act hurriedly upon it, which creates momentum. Usually, such momentum exists for a short-term, i.e., between six to 12 months.

Varieties of momentum
There are two kinds of momentum investing methods—time-series or absolute momentum and cross-sectional momentum. Beneath time-series momentum, the efficiency of an asset is in comparison with its personal historic efficiency. As an example, rating of shares on their very own 12- month efficiency would offer a listing of shares which have rallied essentially the most.

Time-series momentum might be recognized by holding a sure revenue share as threshold, and customarily these shares / property which have exceeded the brink are purchased. In case of relative momentum, the involved property efficiency is in contrast with different comparable asset lessons. As an example, gold rallied over a 12 months by 15% whereas fairness rallied 12% throughout the identical interval. So, the relative momentum of gold is greater than that of equities.

Benefits and related dangers

Momentum investing is totally different from that of the normal worth investing philosophy of shopping for low and promoting excessive. The main benefit of this technique is that buyers are shopping for an asset which is already transferring up. So, there is no such thing as a have to determine an undervalued asset and watch for the market to recognise the identical to make revenue. One other benefit is that there exists a possible for top income inside a brief span of time. As buyers are making use of the market volatility to their benefit, the momentum investing helps to maximise the return on funding.
Traders ought to perceive the related dangers of following momentum funding technique. Beneath this methodology, one is investing in an asset class purely primarily based on current shopping for behaviour of different market members. There is no such thing as a assurance that such shopping for behaviour will proceed to push the worth greater.

A considerable amount of empirical proof and back-testing strategies help that momentum buying and selling methods are worthwhile and whereas utilizing such methods buyers ought to remember the above mentioned points.

The write is a professor of finance & accounting, IIM Tiruchirappalli