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 the 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 which 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 those 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 which 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 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 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. You can see the complete list of today’s Zacks #1 Rank stocks here.
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 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 eight stocks that made it through this screen:
TriNet Group, Inc. TNET provides human resources solutions for small and mid-size businesses in the United States and Canada. The stock has rallied 68% in the past year and has a Momentum Score of B.
SodaStream International Ltd. SODA manufactures, distributes, and sells home beverage carbonation systems. Its home beverage carbonation systems enable consumers to transform ordinary tap water into sparkling water and flavored sparkling water. The stock has appreciated 61.8% over the past year and has a Momentum Score of A.
Weight Watchers International, Inc. WTW, whichprovides weight management services worldwide, has gained a whopping 201.8% in a year’s time. The company carries a Momentum Score of A.
Virtu Financial, Inc. VIRT provides market making and liquidity services through its proprietary, multi-asset, and multi-currency technology platform to the financial markets worldwide. The stock has appreciated an impressive 117.3% 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 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.
Click here to sign up for a free trial to the Research Wizard today.
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.
Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
Virtu Financial, Inc. (VIRT) : Free Stock Analysis Report
SodaStream International Ltd. (SODA) : Free Stock Analysis Report
TriNet Group, Inc. (TNET) : Free Stock Analysis Report
Weight Watchers International Inc (WTW) : Free Stock Analysis Report
To read this article on Zacks.com click here.