When value or growth investing fails to fetch sustained profits, one should explore another time-tested winning strategy that simply bets on the frontrunner stocks.
In other words, one of the most successful strategies today is to get in on momentum stocks at the right time.
Momentum is basically the tendency of winning stocks (i.e. stocks that have outperformed the market in recent times) to keep winning and losing stocks to keep losing. It is based on the idea that once a stock establishes a trend, it is more likely to continue in that direction instead of moving against the drift.
At the core, momentum investing calls for investors to “Buy High, Sell Higher.”
Momentum versus Other Styles
It is worth pondering over how the momentum strategy compares to the other styles of investing over time. Recent research indicates that the size premium for small-cap stocks has shrunk dramatically since the 1980s; value premium has also declined dramatically since the1990s.Academics are of the opinion that once research on factor premiums (like size and value) become known to public, the investment world catches on and the premium gradually erodes.
However, unlike other investment styles, momentum premium has stood the test of time, remaining remarkably robust and persistentever since it was identified by financial academics in the 1990s.
But Why Does Momentum Strategy Work?
There is a simple reason to this. It works because we are humans!
There’s a whole laundry list of behavioral biases that most investors exhibit, and these emotional responses and mistakes are the very reason that momentum strategy works. For instance, we all know of investors who are afraid to book losses, and hence hold onto losing stocks for too long, hoping that they will come back to their original prices. On the other hand, investors sell their winners way too early.
Furthermore, investors initially tend to under-react to news, events or data releases. However, once things become clear, they tend to go with the herd and overreact, causing dramatic price reactions.
These behavioral issues extend trends, and thusopen up a huge opportunity for momentum players to make profits. So basically, it’s a way to profit from the general human tendency to extrapolate current trends into the future.
Momentum investing is based on that gap in time that exists before the mean reversion occurs, i.e. before prices become rational again.
Chase the Alpha
Momentum strategies have been known to be alpha-generative over long periods of time and across markets. So obviously, this strategy is quite tricky to implement, as detecting these trends is no child’s play.
Here, we have created a strategy that will help investors get in on these fast movers and make handsome gains. Our screen will help you to take advantage of both long-term price momentum and a short-term pullback in price, which would reflect some profit-taking in the stock.
Screening Parameters
Percentage Change Price (52 Weeks) = Top #100: This itemselects the top 100 stocks with the best percentage price change over the last 52 weeks. This parameter ensures that we get stocks that have appreciated the most over the past one year.
Percentage Change in Price (1 Week) = Bottom #20: From the above 100 stocks, we then choose those that are also among the 20 worst performers over a short one-week period.
Zacks Rank #1: No matter whether the market conditions are good or bad, stocks with a Zacks Rank #1 (Strong Buy) have a proven history of outperformance.
Momentum Style Score of B or better: A top Momentum Style Score knocks out a lot of the screening process as it takes into account several factors including volume change and performance relative to its peers. It indicates when the timing is the best to grab a stock and take advantage of its momentum with the highest probability of success.Stocks with a Momentum Style Scoreof 'A' or 'B,' when combined with a Zacks Rank #1 (Strong Buy) or #2 (Buy) handily outperform other stocks.
Current Price greater than 5: The stocks must all be trading at a minimum of $5 or higher.
Market Capitalization = Top #3000: We have chosen stocks that are among the top 3000 in terms of market value, to make sure that our stocks have strong liquidity.
Average 20-Day Volume greater than 100,000: A substantial trading volume ensures that these stocks are easily tradable.
Here are five of the 12 stocks that made it through this screen:
Murphy USA Inc. MUSA, which operates a chain of retail stores in the United States and offers motor fuel products and convenience merchandise, gained nearly 47% over the past one year, and sports a Momentum Style Score of ‘A’.
Stepan Company SCL produces and sells specialty and intermediate chemicals to manufacturers for use in a broad range of end products globally. The stock has appreciated almost 41% in the past one year, and has a Momentum Style Score of ‘B’.
Astec Industries, Inc. ASTE designs, engineers, manufactures, and markets equipment and components mainly for the road building, aggregate processing, water, geothermal, oil and gas, and wood processing industries worldwide. The stock has gained nearly 53% over the past one year, and also has a Momentum Style Score of ‘B’.
Facebook, Inc. FB, which operates a social networking website worldwide, has soared nearly 32% in the past one year, and carries a Momentum Style Score of ‘B’.
Zendesk, Inc. ZEN, a software development company which provides software as a service customer service platform for organizations, has gone up by over 47% over the past one year, and sports a Momentum Style Score of ‘A’.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
Click here to sign up for a free trial to the Research Wizard today.
Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
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