Millennial investors are flocking to Robinhood, an app that essentially gamifies the process of investing. Investing in Robinhood comes with zero trading fees and account minimums. The ease of trading has turned it into a Silicon Valley darling with a valuation of over $8 billion.
Robinhood investors have a reputation for being irrational and having a significant risk appetite — typically taking up more risk than Russell 1000 stock investors. With the average of Robinhood investors at 31, more half of its users have never invested previously. Hence, investing in Robinhood is marked by minimal use of effective trading techniques.
One of the most effective trading techniques is called momentum investing. The technique’s primary concept involves trading assets in line with the recent strength of their price trends. Hence, investors target momo stocks to take advantage of probable price changes and then closing the position once the trend loses its strength.
The goal is to exploit the market sentiment and herding. Robinhood investors tend to ignore or mess up many of the key “momo” investing strategies that could help them reap massive returns. Let’s look at some of them:
- Developing a ranking system for stocks
- Minimalizing idiosyncratic risk by trading a portfolio of stocks
- Using trailing stop-losses
Momo Investing: Developing a Ranking System for Stocks
One of the most effective strategies in momo investing involves developing a ranking system for purchasing stocks. Typically, an effective momo stock’s criteria are based around its volume, volatility, and time frame.
Volume is significant for momentum traders as they need flexibility in entering and exiting positions swiftly. Hence, markets with greater volume will be more liquid, enabling investors to exchange an asset for cash with ease.
Additionally, momo investors will seek out volatile markets as it allows them to benefit for short-term rises and drops in an asset’s value. In terms of time frame, most momo investors will be looking at short term horizons. However, it also depends on long the trends maintain their strength. Hence momentum traders will rank stocks based on the elements mentioned above and pursue them accordingly.
Minimalizing Idiosyncratic Risk by Trading a Portfolio of Stocks
Minimalizing idiosyncratic risk is a no-brainer for any sensible investor. It is essentially the inherent risk that comes from investing in a specific asset. It is a risk that can be spread out by creating a deeper and a more diversified portfolio. Hence, the goal is to own a considerable number of investments in more than one asset class.
Momo investors will typically develop a more aggressive portfolio, which targets stocks with a high beta. High beta stocks tend to be more volatile, and their price movements are much greater than the market. However, it is also essential to have other stocks and assets to minimize the downside risks. This is something that Robinhood investors tend to ignore.
Using Trailing Stop-losses
Another strategy that momo traders use is called trailing stop loss. It is essentially a day trading order, where investors can set an upper limit or a specific percentage of loss they are willing to incur. Hence, if there is a favorable move, the stop price moves along with it, but the stop price stays the same if it falls against you.
For example, let’s say you purchased XYZ stock for $200, and your stop-loss is $20. If the price goes over $240, your trailing stop loss would be $220 ($240-$20). Hence, you’ll exit the trade if the value drops to $220.
To use a stop loss is to identify the trend you target, use an appropriate moving average, and exit when the price goes beyond it. For the short and medium-term, it’s best to use 50-period moving averages while it can be stretched to 200 periods for the long term.
On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.