Momentum Investing Methods
Momentum investing usually involves abiding by a strict set of rules based on technical indicators that dictate market entry and exit points for particular securities.
Momentum investors sometimes use two longer-term moving averages (MAs), one a bit shorter than the other, for trading signals. Some use 50-day and 200-day MAs, for example. In this case, the 50-day crossing above the 200-day creates a buy signal, while a 50-day crossing back below the 200-day creates a sell signal. A few momentum investors prefer to use even longer-term MAs for signaling purposes.
Another type of momentum investing strategy involves following price-based signals to go long sector ETFs with the strongest momentum, while shorting the sector ETFs with the weakest momentum, then rotating in and out of the sectors accordingly.
Other momentum strategies involve cross-asset analysis. For example, some equity traders closely watch the Treasury yield curve and use it as a momentum signal for equity entries and exits. A 10-year Treasury yield above the two-year yield generally is a buy signal, whereas a two-year yield trading above the 10-year yield is a sell signal. Notably, the two-year versus 10-year Treasury yields tend to be a strong predictor of recessions, and also has implications for stock markets
If you intend to practice momentum investing, make sure you choose the proper securities and consider their liquidity and trading volume.
In addition, some strategies involve both momentum factors and some fundamental factors. One such system is CAN SLIM, made famous by William O’Neill, founder of Investor’s Business Daily. Since it emphasizes quarterly and annual earnings per share (EPS), some may argue it’s not a momentum strategy, per se. However, the system generally seeks stocks with both earnings and sales momentum and tends to point to stocks with price momentum, as well.
Like other momentum systems, CAN SLIM also includes rules for when to enter and exit stocks, based mainly on technical analysis.
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