ETFs for Riding High Momentum

August 10th at 6:00am by Tom Lydon

Momentum investing is an innovative exchange traded fund strategy that capitalizes on the “rate of change” from single stock price movements relative to broad markets. The theory rotates around Newton’s law that a stock moving higher will take off and soar and those trapped in a negative trend will remain trapped.

“The key danger to the strategy is its tendency to blow up spectacularly, especially during bear markets. Momentum can also lag the market for years on end, as in Japan. However, momentum’s risks can be mitigated with an offsetting exposure,” Samuel Lee wrote on Morningstar.

Momentum, or the tendency for prices to trend, can generate market-beating returns in almost every stock market analyzed.Subsequent research has uncovered momentum in virtually every market studied, including commodities, currencies, stocks, and bonds, and over wide-ranging periods, reports Lee.

However, momentum investing is meant to be a monitored and short term trade, due to the fact that just as a stock can soar higher, it can also decelerate at a faster rate than the broad market, magnifying losses. Two key ingredients to momentum investing are almost taboo in todays market – market timing and stock picking. [Are ETFs Turning Investors into day Traders?]

Thus, ETFs can help investors employ a momentum strategy but with a basket of tradable shares, rather than picking random companies trending higher. The investment strategy would allow investors to capitalize on the upside of a sector or asset class, and avoid some of the stocks that are flagging, reports Eric Dutram for Zack’s. [How to Sift Through the Hundreds of New ETFs]

At this time, ETF liquidity in this sector is low. This is the biggest risk associated with investing in high momentum ETFs. Note that these funds also have a low correlation to the broad market, reports Dutram. [Risk On - Small Caps Leading the Way So Far in August]

Various high-momentum ETFs:

  • Russell 1000 High Momentum ETF (NYSEArca: HMTM)
  • Russell 2000 High Momentum ETF (NYSEArca: SHMO)
  • ELEMENTS SPECTRUM Large Cap U.S.  (NYSEArca: EEH)
Tisha Guerrero contributed to this article. 

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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