Momentum Trading and Investing

Jul 13, 2024

Momentum Trading and Investing

Introduction

  • Objective: Understand momentum trading and investing strategies
  • Retail investors: Usually buy low, sell high
    • Example: Buy ITC at ₹300, sell at ₹320
  • Concept of buying low and selling high is common
  • Another strategy: Momentum trading - buy high, sell higher

Momentum Trading Strategy

  • Richard Dryhouse: Father of momentum investing
  • Contrasted with Warren Buffett, Charlie M., who don't favor momentum strategies
  • Explanation using Nestle's stock:
    • Buy at highs, sell at higher highs (e.g., buy at point 4, sell at point 5)
    • Continuous buying high, selling higher

Momentum Trading vs. Momentum Investing

  • Momentum Trading
    • Focus on stock price, not underlying quality
    • Trade based on technical indicators
    • Goal: Quick profits from short-term price movements
  • Momentum Investing
    • Focus on fundamentally strong stocks
    • Long-term investment perspective

Technical Indicators and Systems

  • Use of indicators like MACD, RSI, chart patterns, volume analysis
  • Personal system:
    • Step 1: Identify if the stock is at its 52-week high
    • Step 2: If trade goes well, sell at a 30% gain
    • Step 3: If trade goes badly, get out at a 15% loss
    • Strategy is not guaranteed but mathematically sensible (risk-reward ratio of 2:1)

Types of Momentum

  • Downward, sideways, and uptrend moments
  • Simplified practical setup:
    • Identify the stock's trading range (52-week high)
    • Repeat previous highs

Execution of Strategy

  • Example of identifying and analyzing Nestle's stock based on peaks
  • Timing for buying and selling

Choosing Stocks for Momentum Strategy

  • Focus on fundamentally strong stocks
  • Example using Screener:
    • Filter for 52-week high, market cap > ₹25,000 crore, low debt
    • Generates a manageable list of 60-70 companies to analyze further

Risks of Momentum Strategy

  • Misidentifying good assets
  • Applying strategy to penny stocks and non-fundamentally strong stocks
  • Importance of diversification
    • Avoid concentrating investments on one stock
    • Example: Divide investment into multiple stocks

Final Notes

  • Momentum trading and investing is a hybrid approach
  • Not suitable for pure traders or pure investors
  • Importance of discipline and risk management

Conclusion

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  • Comment with stocks that fit this strategy