In very simple words momentum investing means investing in the current trend. So if a particular stock has been going up in the past few days /weeks, the investor buys the stock. And if a particular stock has been going down in the past few days/ weeks, the investor sells the stock. The basic idea is that the current trend will continue.
Sounds simple and correct. Just buy a stock that is seeing its price go up and sell it when it starts to come down. It is quick and simple. Why go through the financials? Why go though fundamentals? At the end of it, it's all about the stock price. So once a trend has been established why bother to study more. It would just waste precious time. Why wait for years to get wealthy when one can become wealthy in a matter of a few days.
And the best part about this type of investing is that it is exciting. When investors discuss this with their friends, they too get excited. Talks like, "buy stock X, price will double in 10 days", or "I bought stock Y. Prices have gone up 30% in 5 days". These are exciting statements. They would give anyone an adrenaline rush.
But do these stocks actually represent great performance? In recent times, a lot of small cap and mid cap stocks were being touted by brokers as ‘multibaggers'. These were stocks that were running up like crazy in matter of days and weeks. No one cared if they were financially sound. Innocent investors were buying them just because their peers were who were in turn buying them just because their peers were. In short, everyone was following the momentum. But the recent bad news of SEBI cracking down the erring promoters for indulging in insider trading practices, has reversed this momentum. Some of these stocks have crashed down by almost 50%. All the gains made earlier were wiped out in a time period that was so short that investors could not even recover their principal investments.
This is exactly what happens in momentum investing. When the going is good, there are gains. But when the going gets bad, the pain is way more severe. So it is important to look at a company's fundamentals before investing in a stock. It may translate to slow returns but it is good to remember that the slow and steady always wins the race.