momentum investing

what it is

Momentum investing is a style, if one can call it that, of buying and selling securities based simply/solely on recent price momentum.  If a given stock is going up, buy some.  If it continues to rise, buy more.  If a stock begins to decline, sell it   …or, for very aggressive players, sell it short.  No fundamental data counts.

Day traders and very short-term-oriented algorithmic players are the main people who use this simple buy-if-they’re-going -up, sell-if-they’re-going-down rule.  In my career, I’m only aware of two “professional” investment groups who have practiced momentum investing as their main strategy:  Wood Mackenzie trading oil stocks in the early 1980s, Janus trading tech stocks in the late 1990s.  The former was an almost immediate disaster; the latter had a surprisingly long period of success before going down in spectacular flames.

recent use

The term has come into recent vogue in the financial press as a description of growth investing.

It isn’t one, although it may reflect the jaundiced view a few (narrow-minded, in my view) value investors have of their growth colleagues.

To be clear, growth investors try to make money by finding companies that are expanding faster than the consensus expects.  This is not momentum investing.  Nor is the style of value investing that requires that a company not only be bargain-basement cheap but that there be a catalyst (reflected in positive price momentum) for change before buying.

why write about this?

A few days ago, a regular reader, Small Ivy, characterized my speculative dabbling in Tesla as momentum investing.  Maybe so, maybe not.  More tomorrow.

 

speculative stocks: the gold mine paradigm

speculative stock behavior

Speculative stocks of all stripes are often compared with gold mining stocks–not just any gold stocks but young companies with a potentially important strike but no history of profitable production.  Here’s why:

like gold mines

fraud?

In one sense, it’s because gold mining stocks have been fertile areas for fraud, in financial centers from Perth to Denver to Vancouver.  There was even a case in the US many years ago–a major scandal–where a mutual fund took large positions in junior Canadian miners that had fabulous financials indicating deep undervaluation.  When the portfolio manager went to visit the mining operations, however, he discovered they existed only in the imaginations of promoters who were happily churning out fake financial statements.

stock trajectory

Putting such cases to the side, the stocks of legitimate start-up companies often follow the same trajectory as gold miners as they approach the day when their first major development finally comes into production.

–the new strike is announced.  There’s limited exploratory drilling and little other information other than that the find is good enough to be commercially viable.  The stock goes up.

The lack of information itself opens the door to all sorts of speculation.  Analysts, who are always working from imperfect information in any event, may arrive at their preliminary estimates from an average of the productive capability of other mines in the area, or from the past experience of the geologists or the professionals associated with the project.

Even at this stage, analysts begin to jockey for position with each other by offering, in turn, increasingly more optimistic assessments of the find.  The stock goes up some more.

–financing is lined up.  Further drilling has been done to delineate the find and to justify a bank loan that will fund construction of productive facilities.  Getting a loan means a third party has examined, and signaled its validation of, the geological data and production plan.  This sets off another round of more positive speculative assessment of the find.  The stock goes up again.

–the mine and associated processing facilities are constructed.  As analysts can see the scope of the project, even more bullish reports are issued.  The stock goes up once more.

–the mine opens; production commences.  For most stocks this means reality intrudes on–and shatters–the reverie of stock market speculation.  Dream shifts into reality.  Analysts can no longer imagine extraordinarily high ore grade being processed at a world-record rate.  They have to deal with the facts of, say, ordinary grade ore being processed at pedestrian rates.  The stock plummets.

Almost always, the day that the mine opens is also the day that the stock price peaks.