Value Investing vs Momentum Investing

Value Investing vs Momentum investing. Are you an investor who is in a dilemma to choose one among these two? Value investing and momentum investing are two different investment approaches and both have their own strengths and risks. In this article, we provide detailed information on value investing vs momentum investing, important characteristics of both investment approaches, differences between the two and also, which is a better approach.

What is value investing?

In value investing, the investors look for shares or assets that are undervalued in the market. Here, the whole idea is to buy such shares at a reduced price and hold them till the time their actual worth is reflected by the market. Value investing was developed based on the premise that markets overreact to both good and bad news, resulting in stocks being undervalued or overvalued. To identify potential investments, value investors rely on fundamental analysis. To add on, financial reports and company analysis are used as part of fundamental analysis.

Important characteristics of value investing

• Look for undervalued assets
• Have a long-term investment horizon
• Uses fundamental analysis
• Prioritise a margin of safety
• Maintain patience and discipline
• Prefer stable, established companies
• Follow a risk-averse approach

Learn trading from experts! Join today to learn the fundamentals of trading!

What is momentum investing?

When it comes to momentum investing, the technique adopted by investors is to look for stocks or other assets that are rising. Here, the idea is to catch this upward momentum and sell before it falls down. Moment investing works on the premise that stocks or investments that have performed well in the recent past will continue to perform well in the near future. One more belief is that underperforming assets will continue to decline.

Important characteristics of momentum investing

• Concentrate on price trends
• Holding periods will be short to medium term
• Emphasize relative Strength
• Implement technical analysis
• Track trading volume
• Exercise strong risk management
• High portfolio turnover

6 Differences Between Value and Momentum Investing

Now let’s check out the 6 main differences between value and momentum investing.

1. Investment philosophy

The major difference between value and momentum investing is in their investment philosophy. 

Value investing is based on the principle that the market, at times, misprices stocks. Here, the belief is that over time, the market will correct these mispricings and the price of the stock will rise to reflect its true intrinsic value. Patience is of utmost importance in value investing and the core idea is that sound fundamentals will eventually prevail over noise in the market.

On the other hand, in momentum investing, it is believed that trends will continue. Here, investors purchase assets in which the prices are rising and sell those that are falling. This is done with the objective of making a profit from the continuation of these trends. Market psychology plays a role here and it is assumed that upward or downward momentum will continue due to investor behaviour and herd mentality. 

2. Time frame

Generally, value investors will be having a much longer time horizon. They are ready to wait for years for the market to recognize the true value of a company. Instead of running behind quick gains, value investors hold quality stocks that will rise slowly and steadily over a period of time. As a result, they benefit from the dual advantages of price correction and long-term growth.

When it comes to momentum investors, they generally hold stocks for weeks or months. Here the aim is to cash in on the quick price movements before the trend reverses. In short, momentum investors mainly focus on capitalising on short-term market conditions and adjusting their portfolios often, to react to latest trends.

3. Type of analysis

Value investors pay attention to long-term potential and not short-term price action. The technique used here is fundamental analysis and it is done by examining a company’s earnings, cash flow, book value and debt. Value investors compare a company’s intrinsic value against its market price to determine whether it is undervalued.

In momentum investing, the technique used is technical analysis. It is mainly about studying price charts, market trends and trading volume. Indicators such as moving averages, relative strength indexes (RSI), and other technical tools are used by momentum traders to find the entry and exit points. Instead of focusing on the financial health of a company, here the focus will be more on price patterns and historical data. 

4. Level of risk

Value investing is generally considered to be less risky as the focus is on identifying discounted stocks that are fundamentally sound. It is to be noted that there will be a “margin of safety” in value investing as stocks are bought at a discount to their intrinsic value. The benefit of creating the “margin of safety” is that it protects investors against downside risk. Though it may take a long time for value stocks to appreciate, they are generally considered more stable and less prone to extreme volatility in comparison to momentum-driven stocks.

Since momentum stocks rely on short-term price movements, it is viewed as a high-risk strategy. This is due to the possibility of quick reversal of trends. Hence, in case momentum traders fail to exit positions on time, they have to go through the risk of sharp downturns and rapid losses. In addition to that, since momentum to a great extent is influenced by market sentiment and investor behavior, it can be unpredictable and volatile.

5. Behaviour of the markets

Value investors generally taste success in markets with mispricings, especially in times of downturns or corrections when stocks may be temporarily undervalued. When markets are volatile or go through a bear phase, there may be more opportunities for value investors, as the rest of the investors sell stocks that are out of favour.

In the case of momentum investing, irrespective of whether the market is bearish or bullish, investors can profit as long as clear trends are established. Since momentum investors assume that prices will continue to move in the current direction, this strategy becomes really effective during times of significant market momentum and sentiment-driven trading.

6. Source of income

As you know by now, value investors buy stocks at a discount to their intrinsic value. Thus, they make profits when stock prices increase to reflect its true worth. Apart from that, value stocks often pay dividends paving the way for another steady source of income in the long run.

On the other hand, momentum investors aim to make profit from market timing, purchasing stocks that are on the rise and selling them before the trend reverses. They take advantage of quick shifts in stock prices and this can often lead to rapid gains (or losses) over short periods.

Momentum vs. Value Investing: Which Is Better?

Are you still not able to choose between Momentum vs. Value Investing? To keep it simple, value investing best suits those with a long-term, conservative approach. Also, if you are a beginner or a less active investor, it is better to go for value investing as prices would rebound in the long term before your major goals, such as retirement. 

On the other hand, if you are comfortable with higher risk and short-term market movements, the best approach would be momentum investing. Though it is riskier than value investing, momentum investors may be able to make profits more quickly. Thus, if you are investing for a shorter-term goal, like buying a new bike, value investing would be the ideal option.

Key takeaways

• Value investing is about identifying undervalued companies and purchasing shares at a reduced price, with the hope that the market will eventually correct the mispricing and recognise the true worth of the asset.
• Momentum investing involves purchasing stocks or other assets that are showing a rising price trend and selling those that are falling.
• The 6 major differences between value investing and momentum investing lie in their investment philosophy, time frame, type of analysis, level of risk, behaviour of the markets and source of income.
• Value investing best suits beginners or less active investors, as prices would rebound in the long term before one’s major goals, such as retirement.
• Momentum investing is perfect for those who are comfortable with higher risk and short-term market movement,s as there are chances of making profits more quickly.

Parting Words

The right person to help you guide in value or momentum investing styles would be a stock market expert. Entri Finacademy, a trusted finance education platform with over 9 million students, has a team of highly experienced, expert mentors. With both live and recorded classes and exclusive doubt clearance sessions, these mentors are always available to help you out. Last but not least, at Entri Finacademy, there is the option to learn stock market courses in several regional languages, including Malayalam. To know more about Entri’s courses, click here.