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Momentum Funds – Beating the System

Investing can be an intricate balance of systems as traders look for the best ways to maximize their profits. Some of these systems involved complex mathematics for projecting movements of stocks; some rely on simple indicators that can be found in a company’s financials. In the case of momentum funds, investors look for stocks that are exhibiting traits that are appealing for long-term growth.

Momentum funds invest in companies based on current trends in such things as earnings or price movement. The portfolio manager identifies companies that have been trending in a certain direction, such as a series of very positive earnings statements or increasing price momentum in the short-term. The manager will then take positions consistent with the direction of the trend and attempt to let his momentum fund ride the wave and sell once it has peaked.

Following History with Momentum Funds
While typically known as momentum funds, these can also be referred to as “momo funds”. Momentum funds, which enjoyed a great deal of popularity in the late 1990s, often make investments in companies that sustain their earnings or sales at a rapid pace and are anticipating further increases in the near future. Momentum funds also invest based on such technically-based indicators as price breakouts from historic levels.

The investment premise of a momentum fund has found detractors in the long-term, value oriented segments of the market because it is generally regarded as too difficult to predict short-term price movement. With that said, it is difficult to discount the potential of momentum funds, even in the current market.

For example, an investor who had a momentum fund in 2000, the worst possible time to do so, would still have ended 2006 with a 43% gain if courageous enough to stick with it until then. To compare, the Standard & Poor’s 500 index gained just 8% during the same time assuming that the dividends were reinvested.

Momentum funds can also be a profitable strategy for exchange-traded, diversified stock funds and sector funds. There are several simple strategies for momentum funds, most of which have outperformed the S&P index. One of these strategies involves investing in the 10 S&P industry sub-sectors that were the top performers in the previous year. For nearly 40 years, this system has produced an average gain of 13.4% a year, not including reinvested dividends. By comparison, the S&P 500 has only gained an average of 7.5% a year over the same period.

While such returns are unusual, this is the whole theory behind momentum funds. Investors find stocks that are on the move and take advantage of that fact to cash in on shares that have been tracking profitably. This gives the investor time to identify a solid trend and invest in it, riding the profits until he sees the end of the trend and gets out.

Every investor looks for a way to anticipate stock moments and create solid returns. Momentum funds provide their holders with a strong alternative to other forms of trading and do so with stocks currently performing at a high level.





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