The collapse of world stock markets in the wake of the devaluing of the Chinese yuan and falling growth has come as a shock to momentum investors.
Momentum investing is putting money into shares and markets based on following a trend – and the trend in recent years for China has seemed to show the only way was up.
Now is the time for investors to take stock about how to pick stock and shares.
Investing is based on two strategies –
- Momentum – Following the trend in markets which chases short-term increases in shares and ignores whether the companies really offer value
- Fundamental – Picking stocks based on value and sitting out the trends to see if the investment delivers long-term growth and dividends
Unfortunately, momentum investors are in the middle of a crisis as billions of pounds in value has been wiped off global markets in the past two weeks.
Investing is about timing
The problem with momentum is investors are always following the herd and buying into companies which are already showing a rise in market values and often selling when share prices are at a low.
Momentum investing is about timing when to enter and leave a market, and if the investor makes a wrong call, the results can be disastrous.
Experienced investors will say making a profit each year is unlikely to happen, but making a profit over the long-term is a more likely outcome.
Funds are often criticised for momentum investing as managers are set targets to beat indices like the FTSE100 or FTSE250 each year, but this introduces risk as the fund is trapped in a momentum cycle.
If you invest in funds, some simple rules should help pick the right ones to follow:
- Measure performance by indicators like global GDP plus inflation, not market capitalisation
- Look at cash flow instead of share prices
- Don’t invest in funds where managers follow momentum
Less volatile portfolios
The result should give a stable portfolio that is not so likely to suffer from market volatility. Short term losses will occur but will be less devastating and easier to recover from and long-term gains will improve.
Experts have detailed explanations of fundamental stock analysis online that make a good starting point for investors who want to get away from the up-down cycle of the markets.
Bubbles will burst and markets will correct, but investors can take steps to reduce the risk and financial damage that follows.