Investors are overwhelmed with information that is supposed to help them navigate the market. We hear about valuation, fundamentals, sentiment, economic growth, political issues, chart patterns and so on and so forth, but at the end of the day there is only one thing that matters -- and that is momentum.
Momentum is summed up well in Newton's First Law of Motion, which states that a body in motion will stay in motion unless acted upon by an outside force. Something that is moving tends to keep on moving in the same direction -- and that also applies to the stock market.
It is a pretty simply concept, and is at the heart of passive investing. Over the very long term, the market has positive momentum. It keeps trending upward, so the easiest thing to do is to just sit and enjoy the ride.
In practice, it isn't nearly as simple as that, because momentum works in both directions. When it is working to the downside, it can overcome the longer-term trend and produce heart-stopping drops in value. Since most people need access to their capital at various points in their life, they can't just sit there and wait for the long-term trend to bail them out again.
The important point is that you honor momentum above all else. There are always very loud and very compelling negative arguments about why the market can't continue higher, but almost always they will ignore the power of momentum.
The only thing that predicted with great accuracy that this market would go higher over the last eight years or so was momentum. Momentum always lasts longer and goes further than seems reasonable. You can't argue or reason with it. Momentum doesn't stop until there is some force strong enough to change it -- and that force must be quite powerful.
Most pundits and many investors spend far too much time trying to guess when momentum will finally reverse. Rather than holding on tight and riding it for all its worth, they keep trying to find reasons why it cannot continue.
I don't have to go into all the arguments that exist right now for the end of this uptrend. They have been the same arguments for a very long time. There are always new variations -- such as how the spread between junk bonds and Treasuries is indicating problems, or how narrow the market action has been.
But momentum is not a one-way street. It works in both directions and the people that failed to recognize this in 2000 and in 2007-2008 paid a heavy price. The key to superior long-term results is to avoid those inevitable cycles of negative momentum. There are always advisors urging you to rush in and buy in the teeth of negative momentum. The phrase "buying opportunity" causes tremendous pain when downside momentum finally builds.
The key to embracing momentum is patience. It is very easy to be mistrustful of an uptrend and to be sucked into the timing game. We are easily jiggled out of good positions, and worries about a crash are always lurking. To ride momentum effectively, you have to have some tolerance for pullbacks and dips. It will be a bumpy ride at times.
Eventually, a time will come when we have to recognize that momentum has ended. It is not easy to identify a meaningful shift in the character of the market. If you ride momentum effectively, you will suffer losses when the top occurs. However, if you have indeed ridden the upside momentum effectively, you should also have a good cushion to protect yourself when the turn does come. So often market timers are so intent on trying to call the turns that they miss the runups. They may not lose much money when the market turns down, but they often have missed out on much larger gains.
Once you understand that momentum is not based on anything concrete, or even rational, then you can understand the market much better. You can't argue with it or force it to understand that what is happening in the market is crazy.
If you look at the market through the prism of momentum, your chances for superior returns will be greatly enhanced.
