Momentum is defined as the impetus to go forward, develop or get stronger. In investment terms, employing a momentum strategy is taking advantage of observable trending in share prices.  Simply, a momentum strategy takes into account that stocks that have done well over the previous few months tend to continue to do well over the ensuing months. Likewise, stocks that have been tanking, tend to continue to head south.

For our Private Client Service client, their Australian share portfolio and a portion of their global share portfolio, has momentum-investment filters applied in their fund’s daily trading strategy. The momentum strategy identifies stocks currently in their “buy” category that are showing signs of “downward momentum” so they can be filtered out. At the same time, stocks in the “sell” category that are in “upward momentum” are identified and will usually be held.

In the past year, many stocks that would normally have been sold as they became larger and more growth-like, were kept in investment portfolios due to the use of momentum filters. Upward momentum stocks over the past year include Felix Resources, Macarthur Coal, Incitec Pivot and Santos.

Examples of Momentum: Comparative Returns (2007/08)

Source: Bloomberg

Momentum investing seeks to identify a company that is improving at a faster rate than the market. Momentum investors also seek out average companies that are becoming good, and good companies that are becoming great.

There will be periods when utilising a momentum filter could detract from returns, however, when used as part of a balanced strategy and over the long term, it is believed that using these filters will add value to a portfolio.

Tags: Investment strategy