If there’s a mantra that Money & Markets Chief Investment Strategist Adam O’Dell lives by when it comes to stock trading, it’s this: “Buy high … sell higher.”

Adam believes in it so much that he calls it the Momentum Principle. And it’s the key component to his six-factor Green Zone Ratings system.

Adam has spent countless hours reading thousands of pages of academic research. He came to the conclusion that trading momentum is the best way for investors to make money.

Here’s why:

  • Momentum has a successful track record that stretches more than 200 years.
  • Momentum provides stronger market-beating returns than all other strategies.
  • Momentum works on all types of investments, not just stocks.
  • Momentum is easy to trade.

It’s why momentum is one of the six factors Adam uses in his Green Zone Ratings system.

Today, you’ll learn all about how momentum fits into Adam’s investing philosophy.

‘Buy High and Sell Higher’

In a recent interview with Money & Markets Assistant Managing Editor Chad Stone, Adam summed up momentum this way:

I think momentum is key when figuring out if it’s the right time to invest in a certain stock. In the simplest terms, momentum boils down to buying ‘buying high and selling higher,’ according to the earliest momentum traders.

To put it simply, momentum trading takes advantage of investor bias.

It’s natural for investors to use data as a starting point, but emotion as the primary reason we buy or sell.

For instance, we sell when we fear a price drop because of weaker earnings, instead of selling because the data confirms it.

Another example is individual investors selling or buying a stock because that’s what a larger group of investors does, rather than let the data point them in the right direction. This is called “herding.”

These biases can create the mispricing of stocks — high or low. That mispricing is when momentum traders can strike and earn market-beating returns.

How Momentum Fits in the Green Zone Ratings System

Closing Bell stock market momentumNow, Adam’s Green Zone Ratings system is simple on the surface. But it gets more complex as you dig deeper.

The six factors — momentum, size, volatility, value, quality and growth — include several sub-factors that, when combined, give a stock its overall score (from 0 to 100, with 100 being the best).

Without getting too deep in the weeds, Adam’s momentum uses three sub-factors:

  • DMI — The Directional Movement Index, or DMI, shows the direction the price of a stock is moving.
  • Up/Down Volume — This is a ratio that takes the stock’s trading volume on days when it’s up and divides it by the volume traded on days when it closes down.
  • Trailing Returns — This shows how a stock performed on a historical basis. It basically looks back at a stock’s annualized return over a specific period of time.

These three sub-factors combine to give a stock a score on momentum.

That score combines with scores from the other five primary factors to give a stock an overall score.

It seems like a lot at first, but know that the system works.

Some of the high-momentum stocks we’ve written about include…

  • PennyMac Financial Services Inc. (NYSE: PFSI) — up 22% in less than two months.
  • Aspen Group Inc. (Nasdaq: ASPU) — up more than 18% in two months.
  • Collectors Universe Inc. (Nasdaq: CLCT) — up more than 16% in less than two months.

In the coming weeks, I’ll talk more about the other five factors and how they’re used in the Green Zone Ratings system.

Until next time…

Safe trading,

Matt Clark signature

Matt Clark

Research Analyst, Money & Markets

Matt Clark is the research analyst for Money & Markets. He’s the host of our podcast, The Bull & The Bear, as well as the Marijuana Market Update. Before joining the team, he spent 25 years as an investigative journalist and editor — covering everything from politics to business.