In a bull market, when valuations are expanding and the market is pricing in a better future, there’s no faster road to profit than buying momentum stocks. When a stock is on the move, there’s a good chance it will continue in the same direction, especially if the power of institutional buying is behind it.

"An object at rest tends to stay at rest and an object in motion tends to stay in motion with the same speed and in the same direction unless acted upon by an unbalanced force." - Isaac Newton

In this latest in The Strategy Map series, I'll be giving you an overview of momentum investing, and introduce two approaches to capturing its rewards - the active trader approach of buying breakout stocks, versus the more systematic approach of buying and holding portfolios of higher strength stocks.

Is “Big Mo” right for you?

Momentum investing isn’t for everyone. It requires a watchful mindset, and a willingness to prioritise technical analysis (price action and sentiment) over fundamental analysis (valuation and company accounts). While a value investor seeks to buy stocks cheap, often buying after declines, the momentum investor seeks to “buy high and sell higher”. If your belief system rests on a deep value margin of safety, you may find momentum investing challenging.

This is an active approach that requires regular dealing and a keen attention to risk management. It's common to use stop losses to protect capital, and cut positions as soon as trends reverse. If you don't have the ruthless streak, and prefer the idea of marrying compounding quality stocks for life, you will want to look away now.

Nonetheless understanding how to read the runes of price and volume action provides invaluable lessons for all investors. Let’s get to grips with this compelling approach to beating the market and put Newton's Law of Motion to work.

Background to Momentum Investing

One of my favourite stock market stories was told by the globe-trotting Hungarian-Canadian ballet dancer, Nicholas Darvas in his classic 1960 "How I made $2,000,000 in the stock market".

Darvas's book may be more than 60 years old, but his tale reads timelessly. He made every mistake in his early years, buying on tips, trying to play it safe, over-relying on fundamentals, until he realised through keen observation that price and volume action held the key to sustainable profits.

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