Do you feel forward-leaning and on your toes? Or do you spot trends where others see random movements? Then you might fall into the philosophical category of momentum.

Cathie Wood: momentum queen

In the momentum camp you’ll find good company with investors more inclined towards day trading – and with big players like Cathie Wood.

– Are you an alert and trend-sensitive player who rides the wave?

Ark Invest founder Cathie Wood is sometimes mentioned as one of the best in the momentum branch. She has made a name for herself with her bold bets on what she deems to be disruptive companies that will revolutionize their respective industries. This includes everything from AI and automation to blockchain technology.

Wood is on her toes and adjusts the portfolio frequently as market trends change or the tech industry delivers new advancements. Among other things, she managed to spot Tesla early on, an investment that paid off handsomely. She also invested in the video communication company Zoom, which skyrocketed when the pandemic hit and forced office workers worldwide to work remotely.

The key, according to Wood, is to anticipate the next wave – and make sure to be ready on the surfboard when it comes.

It’s a slightly different approach than what the manager Richard Driehaus used to employ. He may be somewhat less known, but he is actually often referred to as the “father of momentum investing”. He studied more short-term trends and made sure to jump on stocks where he saw prices trending upwards, for example, after a report that surprised on the upside. “Buy high and sell even higher” was one of his sayings. “Cut the losers and let the winners run free” was another.

Market outlook

In essence, momentum investors believe that what goes up is likely to continue going up, and vice versa. At least in the short term. The assumption is that prices move in cycles, and therefore, one can roughly determine where an asset is in its movement and take advantage of it. So, the philosophy has some overlap with day trading, but momentum investors often hold onto their holdings much longer and keep an eye on the long-term growth potential.

“All who bet against American innovation in the long run are probably making a bad deal“

The idea behind momentum philosophy is that everything moves in cycles and trends are waves to ride. In the long run, it can involve things that are truly transformative – like electric cars, video communication companies, or cryptocurrencies.

Momentum investors don’t hesitate to buy in expensively, if there’s an opportunity to sell even more expensively (to an even bigger fool, ehum ‘momentum believer’).

Exactly why it works is debated among academics. It goes against a whole range of established theories and hypotheses.

“Early 2021 we couldn’t do anything wrong. Everyone wanted to talk to us. Today we can’t do anything right, according to the media” – Cathie Wood

But that it works has been proven by both investors and researchers. In a study from 1993, two economists from UCLA Anderson showed that the momentum strategy delivered significantly greater returns than the market as a whole between, the admittedly very short period of 23 years, 1965 and 1989.

Advantages and disadvantages

For some momentum investors, only graphs matter as decision-making tools. That means there’s not much to discuss. If the graph shows a sell signal, just follow along. If it goes well, you can earn a tidy sum.

Others make sure to be quick on the train if a stock starts to rise or fall rapidly in the wake of a company report, a changed stock recommendation, or an analysis. If the analysis is correct, that a price in an upward trend continues upwards – and the investor manages to get out before it goes downwards again – the profit rolls in.

“There is a historic and massive misallocation, where investors bet on the past” – Cathie Wood

But the basic idea, that stocks in upward or downward trends continue in the same direction, doesn’t always hold. On the contrary. If things go wrong, a momentum investor can therefore lose a lot on their bet. Cathie Wood’s flagship fund Ark Innovation ETF recently experienced a crash of 60 percent, and for a while, it seemed more successful to simply do the opposite of what she did.

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