| Two popular terms which often confuse
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| | the effort of actively managing a
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| investors are "trend following" and
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| | portfolio. The simple answer lies in the
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| "momentum investing." Perhaps the most
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| | proven behaviors of economic cycles and
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| glaring commonality between these two is
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| | sector rotation. Independent studies
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| their blatant defiance of "buy and hold,"
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| | have proven that over time the largest
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| the practice of selecting an investment
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| | percentage of a securities' price
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| and holding it indefinitely, believing
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| | appreciation is driven by the industrial
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| that over time the market goes up, and
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| | group within which the company is
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| therefore any investment will appreciate.
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| | classified and not the performance of the
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| Although the buy and hold approach has
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| | individual company itself.
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| been touted for years by academics as the
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| | However, the real reason why investors
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| best method of investing, in reality it
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| | should actively manage their portfolios
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| has its shortcomings, which are apparent
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| | is a concept called the "Time Value of
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| in every Bear market.
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| | Money," also known as "Compounding Rate
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| Despite being the antithesis of buy and
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| | of Growth." Many financial professionals
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| hold, both momentum investing and trend
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| | will use the example of how a penny, if
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| following strategies are predicated upon
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| | doubled every day, is worth over $10
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| a disciplined investment approach that's
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| | million after only 30 days. A very
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| designed to buy when the price of an
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| | impressive and eye opening number given
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| issue is increasing and sell when the
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| | the small amount of initial capital
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| price is declining. Additionally, an
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| | outlay. What would happen if instead of
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| exit strategy is normally incorporated to
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| | doubling the penny every day, it were to
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| override the human tendency to hold
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| | grow by only 75%? The investment would
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| losing positions much too long. Yet
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| | be worth slightly over $195,000 rather
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| despite the distinct characteristics that
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| | than $10.7 million. Reducing the growth
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| these two terms share, in reality they
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| | rate further to 50% and the end value is
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| are quite different.
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| | now $1,917.51. A 25% growth rate for 30
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| What is Trend Following?
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| | days produces a value of only $8.08.
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| Trend following, in its most basic
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| | How does the concept of compounding
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| definition, is a systematic investment
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| | growth translate into the selection of an
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| approach predicated upon buying and
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| | investment strategy? Investors who
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| selling securities based on the sustained
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| | actively manage their portfolios, either
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| price movement of the issue. It's
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| | through trend following or momentum
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| important to point out that trend
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| | investing, have the ability to take
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| followers don't predict the future price
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| | modest gains and re-invest the profit in
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| movement of a stock; rather they examine
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| | other trending securities over and over
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| the issue using technical analysis to
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| | again. Buy and hold investors are not
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| determine which direction, if any, the
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| | awarded this luxury since they rarely
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| equity is currently moving. If a bullish
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| | sell when the price is at the top.
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| trend is emerging, the trend follower
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| | Rather, they buy a position when the
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| will likely buy a position in the stock
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| | price is low, ride the position all the
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| and hold it until the trend begins to
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| | way up in a bull market, and then watch
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| weaken or change direction. If the
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| | as is loses value in a bear market. It's
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| equity exhibits a bearish trend, the
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| | a very frustrating strategy, equally hard
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| trend follower can short the position,
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| | on the stomach as it is on the wallet.
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| wait until the trend reverses, or merely
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| | Both strategies, trend following and
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| find another issue.
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| | momentum investing, demand a certain
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| But there's much more to being a
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| | level of self-discipline in order to be
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| successful trend follower than just
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| | successful. A portfolio risk-management
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| selecting and buying securities. In
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| | system that uses the current market price
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| fact, it can be argued that the most
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| | and equity level of a position and some
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| important aspect of trend following isn't
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| | form of market volatility measurement is
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| when and what to buy, but rather when and
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| | recommended. An example of such a system
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| what to sell! Often times, successful
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| | could be a proprietary market model
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| trend followers establish a "sell rule"
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| | focused on technical indicators, back
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| that must be violated prior to selling
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| | tested over time, coupled with a
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| the issue. These sell rules vary
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| | volatility indicator. The system might
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| depending on the risk tolerance of each
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| | employ either the Average Directional
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| investor, but they typically consist of a
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| | Movement Index (ADX/R), the CBOE
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| trailing stop loss coupled with a
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| | Volatility Index (VIX) or the more
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| confirming indicator. The overarching
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| | traditional Advance Decline Line, Breadth
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| benefit of sell rules is that they
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| | or Volume indicators.
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| provide a disciplined, mechanical
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| | Taking Portfolio Risk Management Systems
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| methodology which the average investor
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| | One Step Further
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| should seriously consider implementing
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| | One noted management system authored by
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| into his investment philosophy.
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| | William O'Neil is CANSLIM. The CANSLIM
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| What is Momentum Investing?
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| | approach combines both fundamental and
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| Momentum investors are constantly
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| | technical analysis much like the Core
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| searching for companies that are moving
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| | Equity Portfolio available at QMA
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| faster than the market. They believe
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| | Investment Management, LLC. The weakness
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| substantial returns can be realized if
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| | in the CANSLIM approach, along with many
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| they find, buy and hold onto those issues
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| | other similar systems, is that they stop
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| for as long as the price continues to go
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| | short of providing a truly utilitarian
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| up. The old axiom, "if it isn't broken,
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| | system for the investor. The user ends
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| don't fix it" illustrates the shared
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| | up with a list of stocks, all of whom
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| philosophy of momentum investors; those
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| | have meet the systems criteria, but no
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| companies with the biggest price changes
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| | method for distinguishing between the
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| over the last few months are more likely
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| | good, the better and the best.
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| to continue making substantial gains.
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| | To address this problem, Alpha Advisor
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| Fundamental analysis plays a much bigger
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| | Service, LLC created the AAS Rating
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| role in momentum investing than it does
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| | Score. This number is a time-weighted
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| in trend following. Momentum investors
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| | risk-adjusted alpha value used to rank
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| believe that buried within a company's
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| | each of the 1700 investments analyzed
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| earnings statement is the reason why the
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| | daily by AAS. The purpose of the AAS
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| price has been increasing so
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| | Rating Score is to create a level field
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| dramatically. And if that underlying
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| | to measure all investment alternatives.
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| reason is uncovered, the opportunity
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| | The highest AAS rated securities provide
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| presents itself to capitalize on that
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| | the greatest risk-adjusted return
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| knowledge in the future.
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| | compared to the lowest rated securities.
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| In the case of trend following, investors
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| | This approach is superior to other forms
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| want to identify where a security may be
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| | of alpha analysis since it is
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| within the performance cycle. For
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| | time-weighted, thereby identifying those
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| example, how close to the 52-week high or
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| | stocks or funds that are providing
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| low is the current market price and what
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| | greater returns for the risk taken. A
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| is the short-term direction of the issue?
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| | tool of this caliber, which is available
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| For the momentum investor, the key
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| | for any investor via the Alpha Advisor
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| criteria may be the relative strength of
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| | Service Newsletter, provides the means of
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| the security versus the market or more
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| | not only developing a customized
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| importantly the peer group of the
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| | portfolio risk-management system, but
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| particular security in question.
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| | also a disciplined method of buying and
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| How to Develop a Successful Investment
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| | selling the securities within the
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| Strategy
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| | portfolio.
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| Investors often ask why go through all
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| |
|
