About two decades ago, academics honed in on what we today call the “momentum effect” in stock markets. 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. Unlike the hugely-followed Value or Growth styles, this strategy has barely anything to do with the fundamentals of a company, and instead works with the human penchant to extrapolate current trends into the future.
At the core, momentum investing calls for investors to “Buy High, Sell Higher.”
Momentum versus Other Styles
It is worth reflecting 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 and value premium has also declined radically since the 1990s. 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 ever since it was identified by financial academics in the 1990s.
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 anxious about booking losses and hence hold onto losing stocks for too long, hoping that they will spring back to their previous highs. 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 prolong trends, and thus open 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 mean feat.
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 rake in gains from both long-term price momentum and a short-term pullback in price, which would reflect some profit-taking in the stock.
Percentage Change Price (52 Weeks) = Top #100: This item selects 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 #40: From the top 100 stocks, we choose those that are among the 40 worst performers over a short one-week period.
Zacks Rank #1: No matter what the market conditions are, 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 best to invest in a stock and take advantage of its momentum with the highest probability of success. Stocks with a Momentum Style Score of 'A' or 'B,' when combined with a Zacks Rank #1 or 2 (Buy), handily outperform others.You can see the complete list of today’s Zacks #1 Rank stocks here.
Current Price greater than $5: The stocks must all be trading at a minimum of $5.
Market Capitalization = Top #3000: We have chosen stocks that are among the top 3000 in terms of market value, to ensure 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 10 stocks that made it through this screen:
Tyson Foods, Inc. (TSN - Free Report) , a global food company, has gained over 67% in the past one year and carries a Momentum Style Score of ‘B’.
Cooper-Standard Holdings Inc. (CPS - Free Report) designs, manufactures and sells sealing, fuel and brake delivery, fluid transfer, and anti-vibration systems. The stock has appreciated over 64% in the past one year and has a Momentum Style Score of ‘B’.
Brady Corp. (BRC - Free Report) manufactures and supplies identification solutions, specialty materials, and workplace safety products globally. The stock has gained more than 63% over the past one year and also has a Momentum Style Score of ‘B’.
Infoblox Inc. , whichdesigns, develops, manufactures and sells network control solutions. The stock has rallied nearly 60% in the past one year and sports a Momentum Style Score of ‘A’.
Paylocity Holding Corporation (PCTY - Free Report) , which provides cloud-based payroll and human capital management software solutions, has gone up over 41% in the past one year, and flaunts 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.
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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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