In basketball, when a player hits a few shots in a row, he is said to have a “hot hand.” In finance, we call it “momentum.”
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.
At the core, momentum investing works on the principle of “Buy High, Sell Higher.”
Thus, this strategy calls for hitching a ride on an already fast-moving train, without fretting about valuations or growth prospects. But why does momentum strategy work?
There is a simple reason behind 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 for the momentum strategy to work. For instance, we all know of investors who are afraid to book losses and hence hold on to losing stocks for too long, hoping that they will spring back to their original prices. On the other hand, many investors sell their winners way too early.
Furthermore, investors initially tend to under-react to news, events or data releases. However, once things gain clarity, they tend to go with the flow and overreact, causing dramatic price reactions.
These behavioral problems extend trends, and thus open up huge opportunities for momentum players. 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.
Also, unlike other investment styles, momentum premium has stood the test of time, remaining remarkably robust and persistent ever since it was identified by financial academics in the 1990s. This is especially important as academics are of the opinion that once research on factor premiums (like size and value) becomes known to public, the investment world catches on and the premium gradually erodes.
Obviously, this strategy is quite tricky to implement, as detecting these trends is no child’s play. Momentum strategies have been known to be alpha-generative over long periods of time and across markets. We have devised a strategy that will help investors get in on these trades and make handsome gains.
Our screen will help you take advantage of both long-term price momentum and a short-term pullback in price, which will reflect some profit-taking in the stock.
Percentage Change Price (52 Weeks) = Top #50: This item selects the top 50 stocks with the best percentage price change over the last 52 weeks. This parameter ensures we get stocks that have appreciated the maximum over the past one year.
Percentage Change in Price (1 Week) = Bottom #10: From the 50 stocks, we choose those that are also among the 10 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 cuts short 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 grab 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 other stocks.
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 shows that these stocks are easily tradable.
Here are four of the seven stocks that made it through this screen:
Huntsman Corporation (NYSE:HUN), which manufactures and sells differentiated organic and inorganic chemical products worldwide, has rallied nearly 70% in the past year. The company has a Momentum Score of B.
Cboe Global Markets Inc (NASDAQ:CBOE) operates as an options exchange in the United States. The stock has appreciated almost 75% in the past year and has a Momentum Score of A.
Interactive Brokers Group, Inc. (NASDAQ:IBKR), which operates as an automated electronic broker and market maker in approximately 120 electronic exchanges and market centers worldwide, has gained nearly 69% in the past year. The company carries a Momentum Score of A.
LGI Homes Inc (NASDAQ:LGIH) engages in the design, construction, marketing, and sale of new homes in Texas, Arizona, Florida, Georgia, New Mexico, South Carolina, North Carolina, Colorado, Washington, and Tennessee. The stock has appreciated a whopping 133.4% in the past year and has a Momentum 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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