What is momentum investing? All your questions answered for Wright Momentum & Alpha Prime Smallcase!

by Sonam Srivastava, Siddharth Singh Bhaisora

Published On Aug. 29, 2023

In this article

Here is a full video in Hindi that answers What is momentum investing? and talks about the Wright Momentum & Alpha Prime Smallcase! The text below is a transcript of the video.

What is momentum investing?

Typically, conventional wisdom suggests the key to profitable trading lies in buying low and selling high. Momentum investing, however, proposes a different approach – buy high and sell even higher. Now, that's quite a paradigm shift, isn't it?

This practice of capitalizing on the current market trends to make investments is what sets momentum investing apart. The basic strategy involves investing in companies that are escalating in value, then selling them after they peak and start to decline. This implies that momentum investing is all about aligning your investments with the direction of the share price momentum. To learn more read our in-depth article What is Momentum Investing? A Comprehensive Guide to Understanding Momentum Investing.

How is momentum investing different from trading?

In momentum investing, you buy a stock that is already doing well with the hope that it will continue to rise. You hold it for several weeks or months. In trading, you try to catch small waves, meaning you buy and sell quickly, sometimes even within the same day, aiming to make small profits from each trade. Momentum investing is generally more relaxed because you're not buying and selling frequently. Trading is like a full-time job, requiring constant attention to the market. Main differences are -

  1. Time Horizon: The duration you hold the stock varies. In momentum investing, you hold the stock for several weeks to months, aiming to go along with the upward/downward trend. In trading, stocks or positions may be bought and sold even within the same day, and the maximum duration is usually one week.

  2. Strategy: In momentum, the focus is on buying stocks that show strong performance over 3, 6, or 12 months, etc., and selling those that show weak performance. The assumption is that what has been doing well will continue to do well. On the other hand, trading involves various strategies, focusing primarily on technical factors and news.

  3. Transaction Cost: The cost incurred in buying and selling stocks will be lower in momentum investing as you hold the stock for longer durations. In trading, due to frequent buying and selling, transaction costs can be quite high.

  4. Taxation: In trading, you'll almost always incur short-term capital gains tax since the holding period is from one day to maybe a week. In momentum investing, some stocks might incur short-term capital gains tax if held for less than a year, while others may incur long-term capital gains tax, which is generally more favorable.

  5. Skill and Time Commitment: Both are less in basic momentum strategies. In trading, both are higher because you have to monitor the markets daily and adjust your positions quickly.

Which momentum factor is the best for long term performance?

It's difficult to straightforwardly determine the "best" momentum factor for long-term investing, as markets are constantly changing. However, there are some commonly used momentum factors that people look at.

  1. One popular factor is "price momentum," which simply means selecting stocks that have shown upward price movement over the past 6 to 12 months. Best performing stock of a specific sector over a time period could be considered as a high momentum stock

  2. From a technical analysis perspective several factors such as strong RSI number, good MACD number, breakout charts to determine which stocks are breaking out to determine which is the best performing and high momentum stock in that sector or in that space

  3. Another option could be "earnings momentum," which focuses on companies that consistently surpass their earnings expectations i.e. the company has outperformed the earnings expectations of analysts/ the market. This could be a sign that a company is strong and might perform well in the future.

Before choosing any momentum factor, two things should be considered.

  1. First, diversification is essential. Don't put everything in one basket. If you focus solely on one momentum factor, you'll take on more risk. We utilize over 300+ factors, different tools, and strategies to construct your portfolios.

  2. Secondly, past performance doesn't guarantee future results. Just because something performed well in the past doesn't necessarily mean it will continue to do so in the future. Therefore, it's important to keep an eye on your investments and be prepared to adjust your strategy if things aren't going according to plan.

Yes, in momentum investing, we assume that what's performing well will continue to do so. However, relying solely on historical performance for analysis and decision-making would be misguided. We at Wright Research, rely not just on one best or top performing momentum factor, but rather we take a wide research approach where we analyze multiple momentum factors, along with other important metrics and parameters to come up with detailed investment research and analysis. Choosing multiple different factors, even within momentum, helps us minimize over reliance on any one factor and enables diversification of our stock selection strategy.

For instance, in you may analyzed and found high momentum in the metal sector. One decided to invest in all top performing metal stocks in 2021, but at the same time we heard from China that the metal sector will crash. The lack of diversification here will hurt us. Over concentration of a specific sector or on a specific stock (like buying Adani back when it was booming) can be very detrimental.

Momentum investing in the Indian markets is a strong strategy, but it is not foolproof strategy. Yes, in the long term it tends to perform well. But at the same time having strong risk management practices is imperative. Can you handle the risk that comes with momentum investing? Have you applied stop losses? How will you handle the situation when the market crashes?

Is momentum investing the same as trend investing

Momentum investing and trend investing are like cousins; they are related but not exactly the same. Both strategies involve buying stocks or other assets that are performing well, with the expectation that they will continue to perform well in the future. However, there are some differences between the two.

Momentum investing relies heavily on numbers. Investors often use specific time frames, such as the past 3, 6, or 12 months, to identify which stocks have performed the best. Once they identify these "winners," they invest in them, hoping that their strong performance will continue.

Trend investing is a bit broader. It doesn't just focus on numbers; it also looks at major market trends. For example, if electric cars are becoming popular, a trend investor might invest in stocks of electric car companies. Trend investing also allows for more flexible time frames. You can hold your investment as long as the trend continues, whether that's for months or even years.

In summary, momentum investing puts more emphasis on specific numbers and time frames, while trend investing considers larger market movements and can be more flexible over time.

Does your flagship Momentum Portfolio also consider earnings momentum?

Yes, we at Wright Research also look at earnings momentum, among other factors. The first question is, what is earnings momentum?

Stock analysts analyse and rate/ rank stocks based on their performance and how well they have beaten the expectations of the analysts/ the market. One of the expectations revolves around earnings - how much has the company generated in earnings and by how much has it beaten/ missed the earnings expectation. Earnings momentum focuses on companies that consistently surpass their earnings expectations.

Strong momentum: If a company outperforms the earnings expectations of analysts/ the market on a month-on-month or a quarter-on-quarter or a year-on-year basis, then the analysts will continue to revise the expectations upwards. This could be a sign that a company is strong and might perform well in the future.

So, Yes we, at Wright Research, also look at price momentum and earnings momentum, among other factors.

What is the investment strategy, SIP cycle recommended for the Alpha Prime smallcase?

Alpha Prime focuses on high momentum and is a high risk portfolio. It includes momentum and in the current market the constituents are focused on small caps. It is a 10 stock only portfolio - this means higher risk since there is more concentration and less diversification.

In the rally in the current market I think it's a very interesting opportunity to invest into it. Suited for high risk investors and appropriate for current market conditions and we expect to see good return come out of it and you know that's why we have launched it at this point in time.

For lumpsum vs SIP for Alpha Prime and Momentum - it depends on the outlook we have for the longer term. We are bullish on the India growth story, the Chandraayan-3 moon landing for instance was a spectacular feat and we are expecting great things, at least in the next few years. India’s expected long term growth is high. The outlook is very strong.

So a lumpsum vs SIP in that context doesn’t really matter - lumpsum can also be considered. If you want to maintain a more disciplined approach, SIP is better since Rupee cost averaging will help you optimise your performance for the longer term with minimal effort. Staggering investments over a horizon of say 6-8 months can also be considered. If you expect a correction to occur in the market, maybe the smallcap rally looses its steam for a few months, or the valuations are too high, if that is your analysis then you can start with an SIP approach and deploy more capital when the markets are down/ correction.

To learn more about Alpha Prime read Unveiling Our New Concentrated Momentum, High-Risk Investment Portfolio

How much overlap is there between Wright momentum and Alpha Prime?

The first difference is the number of stocks that we consider. Alpha Prime only considers 10 stocks, while Wright Momentum has 20-25 stocks in it. This leads on to the next point - It means that Alpha Prime is much more concentrated and less diversified than Wright Momentum. Essentially, Alpha Prime is a high risk, high momentum strategy where we take on fewer stocks to generate higher alpha or higher return. Why do we have a smaller universe? Well we expect these stocks to have very rapid momentum and we don't want that to be dampened by diversification so obviously it is a higher risk it is much more concentrated so it can give you higher return at you know higher risk right so that's the difference.

Additionally, Wright momentum is a multi-cap portfolio it is not just focused on small caps, which is currently the case for Alpha Prime, since the market has been trending well for small cap stocks recently. That is not to say that Alpha Prime will always be small caps focused only, but that is the case in the current market right now.

Finally, there will be some overlap in stocks between some of these portfolios, but that is limited in nature. If a stock is present in both portfolios, then we expect it to do well in both the portfolios. And there is a specific thought behind having it at X% or Y% within that portfolio.

To learn more about Momentum Investing and the difference between Alpha Prime & Wright Momentum read Complete guide to Momentum Investing & the Wright Momentum Portfolio

​What happens to Wright Momentum & Alpha Prime when the Market is down? Do we shift to safer assets?

We'll look at the drawdown that hits these portfolios. So let's say we see a 10% drawdown, you will see us deallocating 5% from equity and shifting to safer assets. And incrementally after that as the drawdown increases will keep on reducing the equity exposure adding more cash to the portfolio allocation. This is a systematic approach where decisions are made based on research, backed by data, along with our AI models predictions and quant models analysis.

Allocation will also shift, so let's say if momentum is not working for specific sectors like Banking or Manufacturing, we might see opportunity in other sectors like FMCG etc. And we will pick up those stocks that will be trending and doing well based on our analysis. Ultimately we do not go 100% into cash, and we follow strict risk management practices.

For Alpha prime the rebalancing strategy, around 90% of the time, we will be rebalancing every 2 to 3 weeks while we are actively looking at the portfolio on a day-to-day and a week-to-week basis. For Wright Momentum , the rebalancing occurs once every month, with similar portfolio reviews occurring regularly. If there is a major event that needs action, then we will be very active for both portfolios - with rebalances occurring immediately. We actively look at both of these portfolios and continue to tweak and analyze its performance.

Can I invest in the Wright Research Alpha Prime smallcase or Wright Momentum in the current market? What is the right time to invest in these smallcases?

Alpha Prime is a strong bull market and rallying market smallcase product. When the market is rallying and performing well as it has done in July and also in August, this investment portfolio has done really well and we can expect to see the Alpha Prime smallcase perform well going forward as well. Backtested results are unbelievable - show great performance for Alpha Prime - so it’s an exciting time and let’s see what the future holds. For Wright Momentum , well you can see its historical performance and analyse it and come up with your own conclusions.

On a broader level, these portfolios will do well when the market does well. But we have stringent risk management practices in place that help us deallocate from risky stocks in volatile market conditions, to ensure losses, if any, are limited and the performance of the portfolio is optimised for changing market conditions. Our deallocation strategy has helped us maneuver Wright Momentum and several of our other smallcases and investment portfolios from tricky situations and market scenarios. So excited to see how both of these will perform in the future and grateful for how they have performed so far.

We also continuously research and tweak/ optimise the portfolio to have smoother return profiles, reduce the risk of the strategy and many more things. And that is an ongoing process for us. I am continuously researching on how we can make the return profile even smoother and maybe reduce some risk from the strategy and so on.

What is the best way to invest in momentum - Smallcase or PMS?

Before we can answer this question, let’s understand what is PMS and how much can be invested in PMS.

What is PMS?

Portfolio Management Service (PMS) refers to a professional financial service where experienced fund managers or experts manage an investment portfolio on behalf of individual investors or institutions. PMS provides tailor-made investment strategies, designed to achieve financial goals with the desired risk levels. It entails a diversified approach and includes a blend of assets like stocks, commodities, fixed income, real estate, and cash.

To learn more about this, read our blog on What is Portfolio Management Service - Types and Benefits

What is the minimum investment required to invest in PMS (Portfolio Management Service)?

The minimum ticket size for Portfolio Management Services (PMS) in India, has undergone an evolutionary trajectory. The PMS minimum investment started at ₹5 lakh in 1993, progressively ascended to ₹25 lakh and was increased by SEBI in 2019 to ₹50 lakh. This upward revision was designed to introduce an element of safety and to keep PMS exclusive to investors with higher risk appetites.

This minimum investment threshold serves a multifaceted purpose: safeguarding investor interests, enticing committed participants, and facilitating PMS providers to streamline their services towards a select cohort of high-net-worth individuals. Many argue that this has dampened the PMS segment's growth, but the minimum investment ensures quality of service and that only serious, capable investors pursue this high-risk venture i.e. it caters to investors possessing a more nuanced comprehension of the inherent risks synonymous with PMS.

To learn more, read our article on What is the Minimum Investment Ticket Size for Portfolio Management Services (PMS)?

What is the difference between PMS (Portfolio Management Service) and smallcase?

There are many differences between PMS and smallcase. Here are a few:

  • Minimum Investment Amount: SEBI mandates that you need ₹50 Lakhs or more to invest in any PMS, while smallcase has no such (high) minimum investment requirement

  • Fee Structure Flexibility: PMS fees are typically higher but you can provide a hurdle rate that the portfolio manager has to cross before any fees are deducted. In smallcase, there is only a fixed fee and an AUM fee based model - so there is less flexibility and customisation

  • Rebalancing: In smallcase, you will receive a monthly or, in some cases, a weekly rebalancing from the Investment Advisor. Whereas the rebalancing - the buying and selling is being done by the Portfolio Manager of the PMS

  • Better Pricing: For larger orders, and especially for investors who invest larger amounts in any smallcase, they do so at market orders/ market rates. These can be inefficient and more expensive for the retail investors. Whilst, with PMS larger orders are sliced and executed using algorithms that optimize for getting the best price from the market

  • Investment Discretion: Discretion of buying and selling a portfolio depends on the Portfolio Manager in PMS, whilst in smallcase the final decision rests with the buyer/ investor

Now with Wright Research, you get both advisory via smallcase & our own mutual fund baskets, and portfolio management service (PMS). The advisory has been running for over 4 years and it has done really well. Our branching out into PMS is an extension of what we have been doing with the advisory side. And we are putting in 300% on both Advisory and PMS to ensure you get the best service.

The decision of whether PMS or smallcase depends on your individual risk tolerance, financial goals and preferences. Whether it is our momentum portfolios or our other factor investing, new india, innovation, smallcaps, mutual fund baskets or our PMS offering - there is no difference in our services to you. Feel free to reach out to our team to learn more.

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