Value Investing VS Momentum Investing: Which Method Suits You?
The investment landscape is littered with risks that can quash an investor’s predisposition to make more money. Stock markets, in particular, are always subjected to volatility that investors need to devise methods to contain the risks and earn profits at the same time.
Value investing is the conventional method and widely-used investment strategy. Some would even suggest the style is also the most enduring. However, impatient investors who want to make a fortune quickly through stock trading are going against the conventional method. They have introduced a new strategy called momentum investing.
Tan De Jun, Equity Analyst of iFAST Global Markets, defines value investing as an investment strategy focused on looking for companies whose stock prices are trading below their intrinsic value. “These are companies can be trading at a discount for a variety of reasons despite having strong fundamentals. Value investors seek to buy these “bargains” and hope that as time goes by, the company’s price will eventually converge towards its intrinsic value,” he further explains.
Proponents of this method claim that an investor can make huge profits within a short holding period by exploiting the market’s weakness and imperfections. Still, whether it’s “value” or “momentum” investing, there are consequences to both methods. The choice is often linked directly to an investor’s risk appetite and financial goal.
What is momentum investing?
Momentum investing is gaining ground lately because it feeds on the natural greed mentality of investors. Since some investors claim that it is the fastest method of accumulating wealth, many are encouraged to use it.
TJ Tan, CFA, DCG Capital defines momentum investing as an investment strategy that aims to capitalize on the persistence of existing trends in the market. He explains, “For example, when a stock has gone up over the last week, it is also likely to continue going up in the following time period. Value investing, on the other hand, focuses on the fundamentals of the business and invests in the business with an adequate margin of safety.”
Tan De Jun agrees, adding that it is a strategy that is focused on finding stocks which have had high returns in recent time periods. “The idea behind momentum investing is that stocks that have risen in price tends to attract buyers and will continue its rise while those that have been falling in price tend to attract sellers and will continue its fall. This strategy aims to capture the continuing trend of rising prices before they die out,” Tan De Jun explains.
Investors who use this method basically ‘striking while the iron’ or capitalizing on a stock’s upward price trend. Momentum investors unload their holdings at the most opportune peak before a price reversal happens.
This type of investing has become a phenomenon to a certain degree. Some traders have profited handsomely within a relatively shorter period as compared to value investors. They don’t want to be like the latter that are likely to earn lower profits at a longer waiting period.
The concept of momentum investing
Investors who are into momentum investing specialize in taking advantage of existing market trends. By seizing the moment, they are able to make higher than the standard profits.
They are adept in spotting investment targets, particularly stocks that have shown consistent and steady price increases on the short run. That period is usually in the most recent quarter or not more than one year. They purchase the stocks and then selling them without delay at the first sign of weakness or price decline. Selling needs to be well-timed because that is where the concept is anchored upon.
Dissecting the benefits and pitfalls of the two methods
Both value investing and momentum investing method carry risks. It’s true that value investing has endured the test of time. Billionaire Warren Buffet is the living testament of the method’s efficacy. For one, it follows the basic principle of buy allow and sell high.
You can say they are also opportunists like the momentum investors. Value investors target high profile companies whose shares are taking a beating in the stock market. Because of negative publicity and other issues not related to fundamentals, their prices tend to fall below their intrinsic value.
Momentum investors are the courageous lot. The buying low and selling high mindset plus the longer waiting period is never a consideration. They thrive on the inherent volatility of the market.
Since there is the tendency of investors to react to trends, the herd mentality prevails. In this scenario, the trading volume of a stock can suddenly swell and cause an upward trend in price. This is an excellent situation to assume the leadership position of the herd. They buy the stocks at the start of the wave then sell them when it begins to fall.
The main benefit and pitfall of value investing
“Value investing is a buy and hold strategy and what this means is that investors do not need to constantly monitor the market and make adjustments to their positions frequently,” Tan De Jun explains. However, he also warns that investors should still keep a lookout for major events that may alter the fundamentals of the company. “As a long term strategy, value investing incurs less transaction costs compared to other short term strategies, which may require frequent trading. Value investing requires a contrarian mindset and patience, attributes which many investors lack,” Tan adds.
- Value investing is suited for long-term investors. The potential turnaround of large stocks that are currently undervalued is almost certain. They are prepared to wait in exchange for more promising returns when things ultimately turn for the better.
- The drawback in value investing is the holding period. A high-profile stock would always seek out its ‘real’ value than what the market perceives. However, there has to be a catalyst or driver for the stock price to correct. Otherwise, the holding period can be longer than expected. In extreme cases, the turnaround may never come at all.
The main benefit and pitfall of momentum investing
Tan De Jun also explains that momentum investing is a short term strategy which requires the investor to constantly monitor movements in the market, which can be very time consuming. Weighing the option, he comments, “In momentum investing, frequent trading may also be required, which results in higher transaction fees compared to a buy and hold strategy. Advantages include the potential of high profits within a short period of time.”
- The main benefit of momentum investing is the unmatched speed to earn profits and build wealth. Huge earnings can be derived from trading unheralded or not-so-popular stocks. A momentum investor could realize more than 50% gain by buying and selling these trending stocks at the slightest sign of a plunging trend.
- Momentum investing is a high-risk It is time-sensitive such that a wrong timing could impact and diminish projected gains, if not complete loss of funds. Profits can be realized in short period but the religious monitoring of the stock market is mandatory and therefore time-consuming. Momentum investors are known to breathe, eat, and sleep stock market to ensure the high return on investment.
The long and short of it
Comparing the two strategies, TJ Tan from DCG Capital said, “Momentum investing may be short or long term in trading but value investing takes time for the stock price to converge to its intrinsic value.”
“There is evidence that both strategies can consistently outperform the market. However, as with all disciplines, it requires diligence and some amount of natural talent to put such strategies to work successfully,” Tan concludes.
In the final analysis, the choice of investing method depends squarely on what type of investor you are. Value investing is suitable for long-term investors whereas momentum investing is the short-term method. The fundamental differences are obvious.
A value investor is firm in the belief that the stock of a financially healthy company can become undervalued at certain points in time. That opens a window of opportunity because fundamental analysis would contradict market perception. There’s no emotion involved whatsoever in the decision-making process. Value investors would want to buy a stock that is selling below its fair market value.
Momentum investors can be likened to or if not, are actually technical analysts. Operational performance is of no consequence to them. Their behavior is spontaneous and sometimes irrational. They are emotion-driven. A great deal of time is spent tracking trends as well as upward price movements. When their trades are successful, the high profits justify the higher risks they take.
Momentum investing is vigorous and more effective in a bull market setting than in a bear market. The bull market is characterized by upward market motion as opposed to the downward mobility when the market sentiment is bearish.
Individual investors with limited time and investible funds need to have an ample knowledge of the market and its oddities. It takes a lot of practice before trading skills can be perfected. Only then can one decide which method is suitable.
What are the key areas to look out for?
DCG Capital’s TJ Tan believes that knowing your own temperament is the key to investing. “All forms of investing are likely to be stressful. Momentum investing may require far more attention than value investing. The former relies on constant interpretation and re-interpretation of market signals (such as technical analysis) to determine if the trend is sustained or broken. On the other hand, the latter form relies on an assessment of the fundamentals of a business, and it’s very rare that a good business’ economics are destroyed overnight.”
He quotes the father of value investing, Benjamin Graham. “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
“What matters most in the long run of the underlying substance of the business, can the business sustain its profits, dividends, cash flows or will it wither away? These long-term tends will definitely prevail, being a stock owner you are a partial owner of a company the business performance and the stock price will converge in the long run,” he advises.
Tan De Jun from iFAST Global Markets believes that when deciding on an investment strategy, some areas to note would include looking at factors such as:
- risk appetite
- investment objectives
- time available to monitor investments
- amount of funds available
- time horizon, and
“An investor who is growth-seeking, has a long investment horizon and able to stomach above-average levels of volatility can consider growth investing. On the other hand, value investing is suitable for investors who are patient, able to make investments based on fundamentals rather than “tips”, and prefer to take on less risk than growth investors.” Tan advises.
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