As a trader, you tend to put your money where trading conviction feels strongest. It may be a breakout, the continuation of a trend, or a stock making higher highs. With momentum-based index funds, you get a familiar idea in a more structured investment format.
With mutual funds, you don’t have to track daily charts or react to news flows. These funds invest in stocks that are already performing strongly. So, if you are willing to participate in sustained trends, momentum indices are a disciplined avenue to invest in.
What Is Momentum Investing?
Momentum investments work on the principle that stocks that have performed well in the recent past tend to continue with the impressive performance for some time. Different behavioural factors strengthen momentum investing, like:
- Herding of investors
- Delayed reactions to information
- Gradual institutional accumulation
Momentum investing, therefore, capitalises on the price strength and the persistence of trends. This philosophy feels intuitive for investors as it aligns with breakout strategies and systems that follow trends. However, the key difference is that there’s no discretionary bias in momentum investing. Fund managers rely on predefined rules and not their instincts.
For instance, the Nifty 500 Momentum 50 Index Funds are some of the popular mutual funds where you can invest to ride the momentum.
How Momentum-Based Index Funds Work
With momentum-based index funds, you get a transparent and rule-based framework to invest. Fund managers select the underlying stocks based on their recent performance. These are usually measured over multiple timeframes. The stocks that show the strongest momentum enter the index.
On the other hand, during periodic rebalancing, fund managers remove the ones that lag behind. In the process, only the current market leaders make their way into the index, while past winners are removed. There is no emotional interference since the methodology is predefined.
Why Momentum Index Funds Suit Traders
Momentum index funds are ideal for traders who understand trends but want to reduce the intensity of active management. For busy traders, placing frequent trades or monitoring stop losses can be time-consuming. A momentum fund can give them exposure to trending stocks through a single instrument.
This particularly proves useful during strong market phases, when different sectors witness a rotation in leadership. Momentum funds adjust to these shifts automatically.
Risks and Cycles in Momentum Investing
While momentum investing gives you an attractive investment avenue, the growth trajectory may not be smooth. Sharp reversals are one of the biggest risks, particularly after crowded rallies.
Sometimes, trends change suddenly, and momentum strategies witness short-term drawdowns. Even when markets move sideways or remain volatile, the momentum may be challenged.
As a result of higher portfolio turnover, the fund may underperform temporarily during phases of transition. Traders must understand that momentum works in cycles. Therefore, the strategy includes short periods of underperformance, and it doesn’t mean failure. With patience, you can capture the long-term benefits of momentum investing.
How Traders Should Allocate to Momentum Funds
Momentum funds may be an add-on allocation to your portfolio, but they shouldn’t replace any core components. So, you may consider allocating a specific portion of your capital to momentum strategies, while maintaining exposure in the broader market indices.
Invest in a top ranked SIP mutual fund that will help you smooth the entry points. It also reduces the temptation to go after recent performances.
Conclusion
With momentum-based index funds, you can translate your instincts into a structured and long-term approach. Investors need patience and consistency to respect the trends and avoid overtrading. When you invest with the right approach, momentum funds help you strike the right balance between strategy and simplicity. A thoughtful approach will help you turn the strength of the market into a disciplined investment process.
