The case for value investing vs. momentum trading

Topic: Value investing vs. momentum trading

Summary: Value investors can, and often have to, be truly passive. Momentum traders, on the other hand, have to stay alert and treat their market presence as a job.

I’m a value investor and I’m not at all interested in spending much time on my listed holdings. I’ve got 17 private holdings that are much more interesting.

Length: Very short, basically just a comment on a remark in TIP about value investing being essentially a front running tactic


Billions

Recently, a guest at The Investors Podcast (We Study Billionaires) said “both value and momentum investors need to wait for others to come around to their view“, i.e. , that both styles imply a sort of front running game.

WRONG!

I don’t agree at all.

First, even if nobody ever comes around to the value investor’s view, he will still get his dividends no matter what others think.

Case in point, kind of: I own a small share of an online credit score assessment company based in Holland. It’s private and there is no market in the shares. However I’m getting annual dividends giving me an annual dividend yield of around 65%. Sure, I hope to be able to sell it at a fair value before I die, but until then the dividends are enough.

And, don’t worry about me, there is a sort of gray market, or at least interest in buying out the minority, so I could sell at 30x the dividend now if I wanted to.

Second, momentum investors on the other hand suffer permanent losses when their holdings take an unexpected wrong turn, since there is nothing backing it up long-term. There is zero staying power in momentum trading, and you simply have to take your losses quickly if the trend changes, whereas a value investor can simply wait, and add more to the position if desired.

There is nothing wrong in being a momentum investor (well, actually there is, but let’s not go there). I’m sure it’s a very good strategy for certain “investors”. I, however, stay firmly rooted in the value camp.

Why? See below.

By the way, talking of Billions. Season 2 is not holding up well. It’s forced, lacks nuance, feels like a caricature of itself and have no resemblance with any large or serious hedge fund. Season 2 is like a pale copy of “Boiler Room”, which by the way was like a documentary of a pretty common practice at the time. Axelrod is supposed to manage billions but he trades in the low single digit millions triggered by 1-10% moves. Laughable.


Value investors can wait, have to wait, are allowed to wait – that’s what I like

  • You can both catch falling balls (not knives), or chase them after the bounce, and be secure in keeping them “forever” if they initially move against you, whereas a (long) momentum investor will get permanently hurt if his momentum stock is subject to negative news or just breaks its technical pattern
  • Value stocks provide passive income (vs. trading being an actual job and the more frequently you trade the better; and it’s the workload I want to get away from when living off of investments)

PS: if you say you actually love researching and trading stocks, then why not do it with fake portfolios?

My guess is you do it to become wealthy enough to do what you actually like doing. Well, a very small minority love sitting in front of their little screens, but that’s not for me – and most likely not for the majority either. Most of us just like sun, travel, good food, drinks, speed and excitement, but end up in cramped offices watching colored numbers and charts on a computer. Sad.


In short my method for value investing is:

  1. filter stocks for fundamental value (topic for a whole book, but do check out my finance posts here)
  2. filter those stocks for technicals (e.g., momentum or other TA patterns)
    1. I usually don’t like chasing stocks even if they are attractively valued
    2. I want to avoid too big an adverse move right after purchasing a stock
  3. buy maybe 1/4 or 1/8 of the position you’re ultmately looking for
    1. gradually increase your stake as you get more comfortable and knowledgeable
  4. hedge the position if the overall market calls for it
    1. i.e., short the market or temporarily sell some of your shares if the stock price surges for no reason; increase again on plunges
  5. take a total pause sometimes, for a week, a month in order to reset psychologically, to divorce from holdings and market calls you are married to
  6. never short, there is no hurry; look for a buying opportunity elsewhere instead
    1. very rarely I actually do short single stocks, but it’s not part of my strategy

I am planning to write a longer post on my actual method, a sort of synopsis of my coming book (not the one I’m writing right now, but the one after that). In it I intend to detail how I go from a hunch or a drive to invest to actually diving in, i.e., how I screen for stocks, what key ratios and other information I check, including the macro environment (overall stock market, overall economy, sentiment, interest rates, other asset classes etc.).

Stay tuned for that, i.e., SUBSCRIBE now.

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4 Comments

  1. I wouldn’t use the term “investing” to describe momentum trading. It is speculation — a kind word for gambling. Unless you are paid a dividend, you are not investing.

    Private investments of the kind you are doing are not available to just anybody with a brokerage account. The dividend yield mentioned is so high either the company was desperate for cash, or somebody is your friend. As you mentioned, the public price would be about 30x higher, putting the yield in the low single digits. Great buy for sure. Congrats.

    • What you maybe didn’t get was that I’ve held the shares for 15 years, during which time they would have increased 30-fold if they were publicly listed. Since they’re not, the shares are going nowhere, but the dividend yield keeps going up as long as the company performs.

  2. Ser frem tik den lengre posten om din investeringsstrategi (og boken). Bra post, som alltid! /JE

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