This may be the oldest successful investing strategy in the world. It’s also the one that individual investors find hardest to follow…
Momentum investing.
“Buy high, sell higher” scares many. And yet, it’s been a cornerstone of professional portfolios since at least the 1920s. It probably even existed before then.
The earliest written explanation of momentum investing that I’ve found is from 1933, when it was described in a Barron’s article by Robert Rhea titled, “A Simple Method to Follow Issues that Fluctuate More Widely than the Averages.”
He showed that stocks that gained the most over the past 15 months gained three times more than stocks that lagged the market over the next year.
Rhea noted: “The calculations involved in this work may be made with amazing speed if the proper type of slide rule is used.”
For many years, I couldn’t find an earlier reference. Then I had a conversation with the first researcher to write an academic paper on the topic, and it led me down a momentum rabbit hole…
Time-Tested Wisdom of 1920s Floor Traders
Robert A. Levy is widely known as a constitutional law expert, but Bob’s first career was in finance. He published the first academic paper on momentum in 1967.
A few years ago, he let me in on the story. Apparently, he learned about momentum from a former business associate. And that man learned the technique from floor traders in the 1920s.
It makes sense traders were using momentum 100 years ago. They didn’t have anything else.
You see, financial statements weren’t always available. It wasn’t until after the 1929 crash that regulations required companies to provide information about operations.
Prior to that, management teams decided what information they’d share. Back then, they weren’t even required to tell the truth when sharing information.
This led to trading based on rumors or price action. While many individuals chased rumors, professionals followed the price action.
In many ways, it’s still that way today.
Why Wall Street’s Elite Buy Stocks With Momentum
Back in 2013, I had the chance to speak to the director of technical research at Fidelity in Toronto. He told me that all the charts prepared by his department included a momentum indicator.
All of the firm’s portfolio managers understood the importance of momentum. After all, their jobs depended on it.
Portfolio managers aren’t just picking stocks they like. They are assembling a group of stocks that are likely to beat the market. If they don’t beat the market, investors take their money and look elsewhere.
Buying stocks with momentum helps these portfolio managers beat the market. In fact, if they held a portfolio of stocks that were in downtrends, they couldn’t possibly outperform the market. That would hurt returns. And more importantly, from their perspective, that would hurt their careers.
Understanding all this, professional money managers like to buy stocks that have strong momentum.
Many individuals take the opposite approach.
We might see a stock that’s down 80% and say it can’t go much lower. We buy. The stock falls 50%, and now it’s down 90%. But it can still fall 100% lower.
As a recent example, that happened with AMC Entertainment Holdings Inc. (NYSE: AMC). In March 2022, AMC was more than 80% below its all-time high and looked tempting. After falling another 95%, the stock is now more than 99% below that high.
It doesn’t even have to be that extreme. You may see a stock they like is down 20% and believe it’s a buy. Of course, that stock can also fall 100% from that level.
So how do you avoid the stocks that lack momentum, and only focus on stocks that are trading higher?
Something you can start to implement with beaten-down stocks that seem attractive is to create a watchlist.
Professionals managing accounts both large and small like this approach because it will never let them buy the bottom. It improves their odds of beating the market, and that helps them keep their jobs.
Every professional I know understands this. But few understand momentum better than Adam O’Dell… He’s helping individual investors tap into the power of this indicator for themselves.
In fact, it’s the driving force behind his Infinite Momentum Alert strategy that has proven to outperform the market 300-to-1 since 1999.
For a short while longer, he’s opening the doors to anyone who wants to get in before his next batch of trades comes out this Friday, February 9. Click here to find out how.
Until next time,
Mike Carr
Chief Market Technician