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Summary
- Stock investors are generally advised by experts to remain invested in a scrip for a long time to get good returns at low risk.
- However, there is a section which is not interested in remaining invested in an equity for a long period.
- Such investors use momentum investing, which is a strategy that seeks to capitalise the continuation of an existing market trend.
Stock investors are generally advised by experts to remain invested in a scrip for a long time to get good returns at low risk. Chances of reaping healthy returns are relatively high for a long-term investor since the associated risk reduces over time. It is an investment strategy widely used by investors across the globe.
However, there is a section which is not interested in remaining invested in an equity for a long period. Such investors prefer to book profits in short periods. They keep booking profits and then move on to the next. In short, these investors make short-term gains and exit at quick intervals. If one is interested in making short-term gains based on the market trends, one must have a thorough understanding of the following points.
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Understanding momentum investing
Momentum investing seeks to gain from the continuation of the current market trends. Under this strategy, investors buy and sell stocks that may record a substantial surge in their prices in a very short span of time. To put it simply, an investor buys stocks that are about to rise and sells them at a much higher price.
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A momentum investor identifies the stocks that have a potential to give high returns over a short or medium period. Momentum investors generally work according to a strict set of rules based on technical indicators that dictate market entry and exit points for specific securities.
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Momentum stocks are known to hit new highs as the market rallies.
In the recent times, five major tech giants collectively known as FAANG - Facebook, Apple, Amazon, Netflix, and Google – are among the stocks that could be categorised as momentum stocks.
How to choose a high momentum stock?
There are several indicators that can be used to choose a high momentum stock.
Rate of change
It is one of the most basic indicators which measures the speed at which stock prices changes within a given period. It forms an oscillator when plotted on a trendline. A value more than zero refers to an upward momentum and vice versa. However, the indicator should always be used along with other momentum indicators.
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Trading volume
Trading volume is another important indicator. A high trading volume shows increased interest and lower trading volume shows lower interest in a stock. A stock with higher volume is picked up by investors.
Relative strength index (RSI)
It is calculated by the formula RSI=100-100/(1+RS). The indicator compares the magnitude of recent gains to recent losses.
Moving average convergence divergence (MACD)
MACD is used to confirm the buy or sell signals for a specific stock, as given by other indicators.
MACD divergence
Some also use MACD (Moving Average Convergence Divergence) to identify the divergence between the stock price movement and the respective indicator.
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The bottom line
Investors can reap high returns using momentum investing. However, using this technique can be risky for newbies since its needs a lot of practice. Investors with conservative risk profile should be careful with momentum investing.
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