Shares in the software group Sage have been on a stellar run this year, but the question now for investors is whether the momentum can persist.
A solid set of full year results last November put the brakes on a disappointing spell for Sage's shares. Since then, the price has bounced back, helped by an positive first quarter trading update in January. With the company's half-year earnings release due on May 17, the market will be watching to see whether Sage's price strength can continue.
Finding stocks that can break-out and move higher on news updates is a tactic used by some of the world’s most successful traders. But it’s not a black-box strategy…
Indeed, knowing the factors that drive relative strength in share prices can help you find profitable momentum trades, too. I’m going to use Sage as an example of how this can work.
How has the Sage (LON:SGE) share price performed?
Sage is a balanced, large cap in the Software industry and it has a market cap of £7,702m.
Over the past year, its share price has risen by 12.8%. Against the FTSE All-Share index, which has been largely flat over the past year, Sage shares have 1-year relative strength of 12.6%.
This is important because relative strength is a crucial tool in the armoury of technical traders and investors. It’s an instant measure of how a stock has performed in comparison with a benchmark.
And while there are no certainties about which way a stock will move next, research shows that price trends often persist.
Studies by Narasimhan Jegadeesh and Sheridan Titman, who are leading experts on momentum, show that stocks with the strongest price strength tend to keep up the pace for anywhere up to one year.
But what causes this?
The answer is that investor behaviour plays a big role. Academics point to two key drivers:
- Under-reaction - prices are slow to move up because investors are hesitant to bid prices higher in stocks that have already been on a strong run.
- Delayed over-reaction - investors chasing rising prices attract the attention of other investors, who follow them into those trades, pushing prices higher and higher.
So the answer is that momentum in stocks with strong relative strength is at least partly caused by a virtuous circle of human emotion. Investors have to constantly re-price these improving shares in their own minds.
It won’t always happen - and it might take some time - but when momentum takes over, it can push prices higher and higher.
Next steps
Sage has clearly been on a strong run recently. Research into momentum suggests that kind of price trend has the potential to continue. But it’s important to remember that while momentum is a powerful driver of stock market returns, it can be also prone to strong pull-backs when sentiment changes - so care is needed.
Disclaimer: These articles are provided for information purposes only. The content is not intended to be a personal recommendation. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser. The author has no position in the stocks mentioned, unless otherwise stated.