momentum trading“Herding behaviour” and fear of missing out (FOMO) are two reasons why momentum trading has been so successful. Picture Getty
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Momentum trading is often supported by theories from behavioural finance, the branch of science that looks at how psychology plays a part in financial decision-making, and hence market outcomes.
Unlike traditional finance theory, which assumes that investors are rational, behavioural finance scientists believe human beings are subject to a variety of biases and emotions that can impact their financial choices.
When it comes to momentum trading – a strategy that involves buying when a stock price is trending up – scientists believe that human behavior and cognitive biases are the main factors why the strategy has been so successful.
There is something called “herding behaviour” – which refers to the tendency of investors to follow the crowd.
“Investors often buy stocks that are popular among other investors, regardless of their intrinsic value,” said a report from Faster Capital.
This behavior is driven by the fear of missing out (FOMO), and the desire to conform to social norms.
“For example, if a stock is trending upwards and everyone is talking about it, investors may feel compelled to buy it to avoid missing out on potential profits,” said the broker.
Another reason why momentum strategy has worked so well, from a psychological point of view, is what’s called Confirmation Bias.
This refers to the tendency of investors to seek out information that confirms their beliefs, and ignore information that contradicts them.
“Investors who believe that a stock will continue to perform well are more likely to buy it, even if there is evidence to suggest otherwise. This bias can lead investors to overlook important information and make poor investment decisions,” said Faster Capital.
At the end of the day, the goal of trading is to make money.
For momentum traders, they make money by entering into trades at key points in the upward trend in order to maximise profits.
Fortunately, there are several indicators to quantify those key points, and here we look at three main signals used by the market:
Traders often view the 52-week highs as entry signals.
This is due what’s called the “52-week high effect” – where if a price has broken out above its 52-week range, there must be some factor that generated enough momentum to further continue the price movement in the same direction.
On the other hand, if a stock is far away from its 52-week high, chartists believe the momentum will continue going that way.
10 ASX small caps at 52-week high
(data from Commsec)
| Code | Name | Price | How far from 52-Week High? | 1 mth return | 6 mth return | 12 mth return |
|---|---|---|---|---|---|---|
| EVE | Eve Health Group | $0.00 | 0.00% | 0.00% | 0.00% | 0.00% |
| AEI | Aeris Environmental | $0.05 | 0.00% | 25.00% | 78.57% | 25.00% |
| AMO | Ambertech | $0.29 | 0.00% | 11.54% | 23.40% | 7.41% |
| CUE | Cue Energy | $0.10 | 0.00% | 49.25% | 53.85% | 47.06% |
| CXZ | Connexion Mobility | $0.03 | 0.00% | 30.00% | 8.33% | 44.44% |
| VPR | Volt Power | $0.00 | 0.00% | 100.00% | 100.00% | 0.00% |
| AAP | Australian Agricultural | $0.02 | 0.00% | 29.41% | 10.00% | 37.50% |
| DCC | Digitalx | $0.07 | 0.00% | 38.78% | 88.89% | 83.78% |
| TCG | Turaco Gold | $0.14 | 0.00% | 21.74% | 145.61% | 115.38% |
| NOR | Norwood Systems | $0.04 | 0.00% | 18.92% | 25.71% | 69.23% |
CUE has been rising since signing a gas supply agreement (GSA) with Arafura Rare Earths’ (ASX:ARU) subsidiary, Arafura Nolans Project, for up to 6.85 Petajoules of gas o be supplied to Arafura for up to five years from 2026.
This includes a two-year extension period which is subject to sufficient un-contracted reserves being available. The GSA is conditional on various conditions precedent being satisfied by Arafura by 30 June.
The GSA is for firm gas supply, with take-or-pay provisions and a fixed price that escalates with the consumer price index.
Group revenues in H1 were $76.6m, down 2.3% from the pcp, impacted by Indonesian import restrictions.
Profit before tax was $12.1m, up 18.1% from the pcp, reflecting improved margins driven by favourable product mix.
Bisalloy says its current order book indicates that H2 FY24 will maintain the strong profit momentum delivered in H1, with an anticipated move towards normalisation of product margins in the second half which will be moderated by lower energy and transportation costs.
Simple Moving Averages (or SMA) is another indicator that can be used to gauge momentum.
SMA is often used to determine whether a stock price will continue in the same direction, or if it will reverse a bull or bear trend.
As a general rule, if the current stock price is above the SMA, the price trend is up. If the price is below the SMA, the trend is down.
10 ASX small caps at prices above SMA
(data from Commsec)
| Code | Name | Last Price Value | Price vs. Simple Moving Average | Price vs. 20 day SMA | Price vs. 50 day SMA | Price vs. 200 day SMA |
|---|---|---|---|---|---|---|
| ADN | Andromeda Metals | $0.03 | >5% Above SMA | >5% Above SMA | >5% Above SMA | 0 to -1% Below SMA |
| AEI | Aeris Environmental | $0.05 | >5% Above SMA | 1 to 5% Above SMA | >5% Above SMA | >5% Above SMA |
| BP8 | BPH Global | $0.00 | >5% Above SMA | >5% Above SMA | >5% Above SMA | -- |
| AGY | Argosy Minerals | $0.13 | >5% Above SMA | >5% Above SMA | >5% Above SMA | < -5% Below SMA |
| BIS | Bisalloy Steel Group | $2.81 | >5% Above SMA | 1 to 5% Above SMA | >5% Above SMA | >5% Above SMA |
| AJL | AJ Lucas Group | $0.01 | >5% Above SMA | >5% Above SMA | >5% Above SMA | 1 to 5% Above SMA |
| AMO | Ambertech | $0.29 | >5% Above SMA | 1 to 5% Above SMA | >5% Above SMA | >5% Above SMA |
| PER | Percheron Therapeutics | $0.09 | >5% Above SMA | >5% Above SMA | >5% Above SMA | >5% Above SMA |
| ASP | Aspermont | $0.01 | >5% Above SMA | >5% Above SMA | 1 to 5% Above SMA | < -5% Below SMA |
| TD1 | TALI Digital | $0.00 | >5% Above SMA | >5% Above SMA | >5% Above SMA | < -5% Below SMA |
The distributor of audio-visual solutions announced $50.9 million in revenue in H1, with growth of 25.6%.
The company recorded strong improvement in EBITDA, with an 80% increase on pcp to $3.6 million.
A fully franked interim dividend was declared at 1.2 cents per share, a 140% increase on pcp.
In terms of outlook, Ambertech said the strong start to the second half gives the board confidence that the business can continue to grow and maintain a dividend of greater than 50% of the full year result.
BPH has recently entered into two new agreements with the China Tobacco group, for the sale and distribution of bird’s nest products via China Tobacco’s outlets in the City of Guangzhou in China for calendar year 2024.
The principal terms of the agreements include: Commencement date 1 January 2024 with a term 12 months.
Products to be supplied include: pure bird’s nest 50g box, and bird’s nest drink.
Guangzhou is at the heart of the Guangdong-Hong Kong-Macau Greater Bay Area, the most populous built-up metropolitan area in the world.
Here’s another momentum signal used by the market – the Relative Strength Index (RSI).
RSI is a measure of the strength of a stock’s momentum, either in the upward or the downward direction, and is used to indicate whether a stock is oversold or undersold.
Generally speaking, an RSI above 70 means a stock is overbought; and an RSI below 30 indicates that it’s oversold.
An RSI above 80 meanwhile is strongly overbought, and an RSI below 20 is strongly oversold.
10 ASX small caps at prices with RSI Oversold signal
(data from Commsec)
| Code | Name | 2 Day RSI | 9 Day RSI | 14 Day RSI |
|---|---|---|---|---|
| AAR | Astral Resources NL | -- | Oversold | -- |
| ALK | Alkane Resources | -- | Oversold | -- |
| A1N | ARN Media | -- | Oversold | -- |
| CVN | Carnarvon Energy | Oversold | Oversold | -- |
| RMI | Resource Mining | -- | Oversold | -- |
| EME | Energy Metals | -- | Oversold | -- |
| CMD | Cassius Mining | -- | Oversold | Oversold |
| LOM | Lucapa Diamond | Oversold | Oversold | Oversold |
| NME | Nex Metals | Oversold | Oversold | -- |
| AFG | Australian Finance | Oversold | Oversold | -- |
NEX reported the Warden’s court decision, and said that Warden has handed down the judgment in the long running applications for forfeiture on Yundamindera tenements.
The Warden found that the company has not complied with expenditure conditions but not of sufficient gravity to justify forfeiture.
A total fine of $30,500 has been imposed on the company.
The Yundamindra tenements form part of Nex – Metalicity (ASX:MCT) joint venture – where Metalicity owns 80% and Nex 20%.
Revenue for the full year FY23 was up 3% to US$49.9m.
Lucapa reported loss after tax of US$9.1m, down 12% from loss of US$10.3m in FY22.
Average price per carat sold in FY23 was US$1,682, versus US$1,576 in FY22.
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