Understanding Market Trends and Momentum Investing
Momentum investing is a strategy that involves watching market trends and buying stocks that are trending upwards and selling those that are losing steam. Unlike value investing, which focuses on buying undervalued stocks and holding them long-term, momentum investing seeks to capitalize on short- to medium-term price movements.
While this approach has been successful for some investors—most notably Richard Driehaus, a pioneer of momentum investing—it comes with higher risk and volatility. Many investors struggle with momentum strategies because they often chase trends too late or fail to manage risk properly.
In this article, you’ll learn:
✅ How to identify strong stock market trends
✅ Key technical indicators for spotting momentum
✅ How to manage risk using stop-loss strategies
✅ Why most investors fail with momentum investing
✅ Case studies, including insights from Richard Driehaus
Before diving in, it’s important to understand the key differences between momentum investing and the buy-and-hold value investing strategy followed by Warren Buffett. If you’re new to different investment styles, check out An Introduction to Investment Styles: Finding What Suits You for a broader perspective.
Market Trends: What is Momentum Investing?
Momentum investing is based on the principle that stocks that have performed well in the past will continue to perform well, and those that have performed poorly will continue to decline—at least for a certain period.
This strategy relies heavily on technical analysis and market psychology, rather than fundamental analysis.
Key Components of Momentum Investing
- Price Trends: Stocks that are consistently making higher highs and higher lows are considered strong candidates for momentum investing.
- Trading Volume: Higher volume during an uptrend signals stronger investor interest.
- Relative Strength: Stocks outperforming the overall market or their industry peers tend to maintain their momentum.
- Market Sentiment: Investor psychology and news can accelerate momentum.
Unlike value investors, who look for stocks trading below their intrinsic value, momentum investors focus on price strength and market trends.
How to Identify Strong Stock Market Trends
1. Moving Averages: Identifying Uptrends
Moving averages help smooth out price fluctuations and reveal underlying trends.
- 50-day and 200-day Moving Averages (MA): A stock trading above its 50-day and 200-day moving averages is considered to be in an uptrend.
- Golden Cross: When the 50-day MA crosses above the 200-day MA, it often signals the beginning of a strong uptrend.
- Death Cross: When the 50-day MA crosses below the 200-day MA, it suggests potential downside momentum.
Example: Apple Inc. (AAPL)
In 2020, Apple (AAPL) formed a golden cross, signaling strong upward momentum. Investors who identified this trend early benefited from significant gains.
2. Relative Strength Index (RSI): Measuring Momentum Strength
The Relative Strength Index (RSI) measures the speed and magnitude of recent price movements.
- Above 70: Overbought (a possible sign of an overheated trend).
- Below 30: Oversold (a possible sign of trend reversal).
- Between 40-60: Healthy momentum.
Example: Tesla (TSLA)
During its massive bull run in 2020-2021, Tesla (TSLA) maintained RSI levels between 50-70, indicating sustained buying momentum.
3. Breakout Patterns: Spotting Strong Entries
Breakouts occur when a stock moves above a key resistance level with high volume.
- Support and Resistance: If a stock breaks through resistance with strong volume, it can signal further upward movement.
- High Volume Confirmation: Higher-than-average volume confirms a strong breakout.
Example: Nvidia (NVDA)
Nvidia (NVDA) broke out past $500 in late 2023 with strong volume, signaling continued momentum as AI-driven demand surged.
How to Ride a Stock Trend Safely
Momentum investing requires strict discipline to prevent emotional decision-making.
1. Use Stop-Loss Orders to Protect Profits
Since momentum stocks can reverse quickly, stop-loss orders help protect gains.
- Trailing Stop-Loss: Moves up with the stock price, locking in profits.
- Fixed Percentage Stop-Loss: Setting a 10-20% stop-loss prevents excessive losses.
Example: If you buy a stock at $100 and set a 15% stop-loss, you automatically sell if it drops below $85.
2. Avoid the FOMO Trap
Many investors chase trends too late, buying near all-time highs.
- Solution: Buy on confirmed breakouts, not just hype.
- Avoid “Hot Stock” Fads: If a stock is making headlines, it’s often too late to enter.
Case Study: Richard Driehaus – The Pioneer of Momentum Investing
Richard Driehaus (1942–2021) was a legendary investor who perfected the momentum investing strategy.
Driehaus’s Momentum Strategy Principles
✅ Buy high, sell higher: Unlike value investors who buy low, he focused on stocks already in strong uptrends.
✅ Look for earnings growth: Driehaus emphasized stocks with high earnings growth rates and increasing analyst upgrades.
✅ Relative Strength Matters: He only bought stocks that were outperforming the market.
✅ Risk Control: He used stop-losses aggressively to protect profits.
Driehaus successfully applied this strategy to growth stocks, generating strong returns.
Market Trends: Momentum Investing vs. Buy-and-Hold Value Investing
| Feature | Momentum Investing | Value Investing |
|---|---|---|
| Focus | Price trends & technicals | Intrinsic value & fundamentals |
| Holding Period | Short- to medium-term | Long-term |
| Risk Level | High | Moderate |
| Investor Type | Active traders | Long-term investors |
| Example Stocks | TSLA, NVDA | BRK.B, KO |
Momentum investing can be lucrative if executed correctly, but most retail investors struggle with it due to high volatility and emotional decision-making.
For a more conservative approach, check out our guide on Free Stock Tools: Essential Stock Analysis Tools for Investors to improve your investment research.
Final Thoughts on Market Trends: Should You Try Momentum Investing?
Momentum investing can be profitable, but it requires experience, risk management, and discipline. If you’re not comfortable with market timing, the buy-and-hold value investing approach is a more reliable long-term strategy.
However, if you do choose momentum investing, follow these key rules:
✅ Identify strong trends using technical indicators
✅ Enter only after confirmation (breakouts, RSI, moving averages, etc.)
✅ Use stop-loss orders to manage risk
✅ Avoid emotional trading and FOMO
Invest wisely and always do your own research before following any investment strategy.
Happy Investing!