Why is it in the News?

Traditionally, experts have advised investors to buy assets when they are selling at low prices, such as during times of a financial crisis, as assets could be found selling at prices well below their intrinsic value. Momentum investing is in stark contrast to this traditional logic.

What is Momentum investing?

• Momentum investing refers to a style of investing wherein investors purchase assets such as stocks or bonds that are consistently rising in price while selling assets whose prices are falling.
  • Momentum investors buy assets with rising prices in the hope that the upward price momentum of these assets would continue, thus allowing them to sell these assets at higher prices in the future to make profits.
  • Similarly, they sell assets that are falling in price expecting the fall in prices to continue for some time.
• Momentum investing is based on the philosophy that there can be discernible trends in asset prices and that these trends tend to persist over time.
• The persistence of such trends gives investors an opportunity to recognise and participate in them early enough to make significant profits from their investments.

What is the Counter-logic?

• Momentum investors often invest money in assets whose prices have scaled new all-time highs, even if these assets are trading at prices that are far above their intrinsic value.
  • Many academic studies have shown that momentum investing can generate high returns that comfortably beat the benchmark indices.
• Momentum investors generally do not conduct a deep analysis of the fundamental or intrinsic value of the assets in which they invest their money.
  • They invest purely based on whether the price of an asset is showing a strong trend, either upward or downward, that they can ride on.
• For this reason, many critics argue that momentum investing can cause an unsustainable rise or fall in prices as momentum investors are blind to the actual value of these assets.
• This, they argue, can eventually lead to heavy losses for investors who are late to sell when the prices of these momentum-driven assets suddenly catch up with the assets’ intrinsic value.
• Some investors may combine value investing, which is based on assessing the intrinsic value of an asset, with momentum investing.
  • These investors believe that taking into account the existing trend in the price of an asset can help save time and boost investment returns.
• It should be noted that traditional value investors believe in purchasing assets that are undervalued and selling them when the price of the asset has risen to match the asset’s intrinsic value.
• It might, however, take many years before the price of an asset rises to fully match its intrinsic value.
• Investors who combine value investing with momentum investing may be able to purchase an undervalued asset at just about the time when its price starts to trend towards its intrinsic value.
• This prevents investor money from being locked in for years in assets whose prices go nowhere.