“Momentum trading” is often said pejoratively. A momentum trader is just somebody who follows trends. Somebody who trades against trends is a counter-trend, or counter-momentum trader. A third type of “non-momentum” trader seeks under-performing stocks that look likely to develop uptrends. This is of course pretty close to what a fundamental value-investor does as well.
It's worth comparing these three types of trades from the aspect of risk management. Trend and counter-trend trades are made by mechanical rules. Following an uptrend, traders set stop losses below purchase price. If the trend sustains, the stop is pushed up while the trade is held. If the trend fails, the stop is hit and some money lost on an exit.
A counter-trend trader short-sells a stock (or shorts the stock future) when he thinks an uptrend is unsustainable. A stop loss is set above selling price. If he's right, he makes some money. Or else, he loses some. These rules are reversed when a momentum trader shorts a downtrend, or the counter-trend trader goes long against a downtrend.
This sort of trade is usually leveraged. Assuming discipline about execution and managing position sizes efficiently, the trader has a good idea how much he may lose on a given trade. A counter-trend trader has price targets, while a trend trader does not.
A non-momentum trade can be made without mechanical rules. The trader or investor is looking for stocks that have been relatively weak performers in terms of price over a long period, while showing signs of fundamental strength, or some promise of improvement.
The investor often doesn't bother to see if the stock has a definable trend, instead making a judgement in terms of relative underperformance over say, three months, or a year. In practice, a non-momentum trader rarely sets stop losses, or price targets, or a timeframe.
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What risks do non-momentum trades run? This kind of trade may not be leveraged, so that's one potential risk eliminated. Let's assume that the investor is also experienced enough to take positions of sizes he can handle.
If the stock moves down, causing capital losses, there is no clear stop loss. There may be an internal “pain limit” where the trader is prepared to exit if he loses a certain amount. But he may have to make a series of agonising decisions about exiting, if losses gradually mount against him. Without a stop loss, there is always the temptation to hang onto a losing trade and hope it will turn favourable.
Supposing the internal pain-limit is not hit, will the trader hold the stock forever, especially if there is no return accruing? Presumably not. But this leads to the concept of taking opportunity costs into account.
If the stock is held for say, a year with no meaningful gains, the investor has lost the risk-free rate of return available from a one-year fixed deposit of the same capital. At what level of opportunity cost, does the investor cut losses? Obviously personal risk-appetite comes into question and again, may vary a lot. The last point is that non-momentum trades also don't have clearly defined targets. If the trade is in profit, when should profits be booked? The investor has to make agonising decisions about booking too early, or holding on too long.
The chances of a “non-momentum” investment making profits are about as good as the chances of a momentum or counter-trend trade making a profit. But I think the average non-momentum investor's thought processes tend to inefficiency because he isn't forced to think about these important details. The risks don't disappear because they are left unstated or unquantified. Setting a stop loss, taking opportunity costs into account, and perhaps, setting potential price targets for profit booking, are all worth considering before making a non-momentum trade.
One point is, setting rules forces the trader to explicitly consider questions such as his individual risk-appetite and to quantify risks. There are other psychological advantages to setting rules. When mechanical rules are set and followed in disciplined fashion, the investor or trader has fewer decisions to make on the fly. Hence, he's likely to make fewer mistakes under pressure.
His state of mind doesn't matter, nor does his ego, as trades unfold. When he makes a profit, it's bound by the preset rules and the same applies when he makes a loss. This is useful because it enables the individual to maintain calm and a calm trader is more likely to be a winning trader.