We will look at how you, as an investor, can tap into trending stocks through momentum index funds.

The Story

An object in motion stays in motion – does that ring any bell? If it does, kudos! Your physics game is strong. That’s quite a nerdy start, right? That too of something that is not at all related to investing. Or is it?

Seems like even investing can not escape the laws of physics. Introducing to you – momentum investing.

What is a momentum index fund?

Momentum investing is based on the idea that stocks that are already rising tend to continue rising for a period, while those falling will continue falling.

The simple principle is ‘strong get stronger’. So it involves adding stocks that are trending upwards and removing those trending downwards.

Now finding such stocks could be tricky if it is getting done by us, humans because we have our own biases.

Instead, what if we just pre-decide the parameters for the stock selection? Pick the stock that fits the parameter and remove those ineligible ones.

So, virtually no human is involved in stock selection after setting the parameters, making the entire process completely quantitative.

That’s a momentum index 101.

Parameters for risk & return in momentum indices

Standard Deviation
This measures how much a fund’s returns fluctuate. Higher values mean more volatility (risk), while lower values indicate more stable returns.

Understanding Momentum Index:
Momentum indices, like the Nifty200 Momentum 30, select the top-performing stocks from the Nifty200 based on recent performance. Rising stocks are kept, while underperformers are removed.

Here’s how the Nifty200 Momentum 30 Index performed over the last 5 years compared to its benchmark index (a standard market index for comparison):

  • Return: 30.53% vs. 21.51% (benchmark)
  • Volatility: 21.77 vs. 18.91 (benchmark)

So momentum indices offer higher returns but come with more risk, balancing reward and volatility in investing.

Why invest in momentum index funds?

1. The trend is a friend

By investing in trending stocks, you can potentially ride those stocks to bigger profits.

2. Automated Rebalancing

These momentum indexes are rebalanced twice a year. So trending stocks automatically replace underperforming stocks.

3. Systematic Approach

It follows a clear set of rules based on quantitative analysis which helps to avoid emotional decision-making, providing better long-term returns.

Who should invest?

The short answer is – aggressive investors. It is suitable for those seeking high-risk and high rewards.

Momentum investing can be rewarding, but it’s not without risk. The key is to balance it with more secure investments. So ideally, it should not be a major proportion in your portfolio.