In basketball, when a player hits a few shots in a row, he is said to have a “hot hand.” In finance parlance, 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 momentum strategy work?
There’s a whole laundry list of behavioral biases that most investors exhibit, and these emotional responses and mistakes are the very reason that momentum works. For instance, we all know of investors who are afraid to book losses, and hence hold onto losing stocks for too long, hoping that they will regain their original prices. On the other hand, investors sell their winners way too early.
Furthermore, investors initially tend to underreact to news, events or data releases. However, once things become clear, they tend to go with the herd and overreact, causing dramatic price reactions.
These behavioral issues open up a huge opportunity for momentum players to make profits. So, 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 that 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) become 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, and we have devised a strategy that will help investors get in on these trades and make handsome gains.
We have created a screen that will help you to take advantage of both long-term price momentum and a short-term pullback in price, which would reflect profit-taking in the stock.
Percentage Change Price (52 Weeks) = Top #100: This item selects the top 100 stocks with the best percentage price change over the last 52 weeks. This parameter ensures that we get stocks that have appreciated the most over the past one year.
Percentage Change in Price (1 Week) = Bottom #25: From the above 100 stocks, we then choose those that are also among the 25 worst performers over a short one-week period.
Zacks Rank #1: No matter whether the market conditions are good or bad, 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 (Strong Buy) stocks here.
Momentum Style Score of B or better: A top Momentum Style Score knocks out a lot of 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 Style 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 or higher.
Market Capitalization = Top #3000: We have chosen stocks that are among the top 3,000 in terms of market value to make sure that our stocks have strong liquidity.
Average 20-Day Volume greater than 100,000: A substantial trading volume ensures that these stocks are easily tradable.
Here are four of the eight stocks that made it through this screen:
Hecla Mining Co. HL discovers, acquires, develops, produces, and markets precious and base metal deposits worldwide globally. The stock has gained over 160% over the past one year, and also boasts a Momentum Style Score of ‘A’.
MasTec, Inc. MTZ, an infrastructure construction company, has rallied over 51% in the past one year, and carries a Momentum Style Score of ‘A’.
Universal Forest Products Inc. UFPI designs, manufactures, and markets wood and wood-alternative products for home centers and other retailers. The stock has soared over 58% in the past one year and carries a Momentum Style Score of ‘A’.
IDEXX Laboratories, Inc. IDXX, which serves the companion animal veterinary, livestock and poultry, water testing, and dairy markets globally, has gained more than 41% over the past one year, and has a Momentum Style Score of ‘B’.
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 also 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.
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
To read this article on Zacks.com click here.