One of the most popular trading and investing techniques is buying upside price momentum. Price momentum is the upward travel of prices over time. In other words, the price momentum theory teaches that higher prices beget higher prices.
The reason it works is because investors are heavily influenced by other investors. This phenomenon is known as “herding behavior” where investors are attracted to higher prices and follow each other buying the shares. In turn, the shares keep being pushed higher over time.
Studies show that momentum buying can make sense in the stock market.
Academics Narasimhan Jegadeesh and Sheridan Titman wrote a paper entitled “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” published in The Journal of Finance in March 1993.
The paper concluded that buying past winners (and selling past losers) allowed investors to achieve above average returns over the period 1956 to 1989. In particular, stocks that were classified based on their prior 6-month performance and held for six months realized an excess return of over 12% per year on average.
Just How Do You Identify Momentum?
There are several primary ways to identify upside momentum in the stock market.
The first and most popular way is by just looking at the price chart. A stock exhibiting upside momentum will be evident as the price bars will be traveling toward the upward left corner.
Secondly, using moving averages, such as the 200-day simple moving average, is another way astute investors identify upside momentum. Stocks with strong price momentum often exhibit price bars moving higher above an upward sloping moving average.
In fact, some investors scan for stocks that have just broken out above the moving average in an attempt to capture the start of an upside trend.
Thirdly, normalizing momentum by calculating a rate of change value can allow you to quantify and rank momentum. This formula is beyond the scope of this article but is easily found by a Google search.
Most investors can effectively use the moving average screening technique to find stocks with solid upside momentum. Screen for stocks that broke out above the 200 days simple moving average on stockcharts.com or another technical analysis website. Many brokers provided trading platforms also have this option built into their suite of technical scanning tools.
Doing The Opposite
In the face of the momentum begets momentum theory, there is a group of successful investors who take the opposite tact. Screening for stocks with strong upside momentum, then analyzing the fundamentals to determine if the stock price indicates an overvaluation has proven to be highly effective. Once the candidate stock is identified as being overvalued, it is shorted to capture the pending downside move off the momentum spike initially identified. Investors utilizing this technique often wait for the stock price to tip its hand by falling off the highs before shorting.
As you can see, there are several ways to play upside momentum. You can either go with or fade it with a short. The same thing can be done with downside momentum, either go with and short or fade it by going long should the news or fundamentals support the contrarian position.
Here are five stocks exhibiting strong upside price momentum:
1. Applied Genetic Technologies (Nasdaq: AGTC)
Over the last week, this stock just exploded higher with massive upside momentum. Hitting resistance at $7.00 per share, my play on this one is to enter longs on a break out above $7.00 per share.
2. Cyber-Ark (Nasdaq: CYBR)
A gap higher off of the 50-day simple moving average reflects strong upside momentum above both significant averages. The fact that the gap has continued into the second day adds to my long technical conviction. Go long from $78.00 per share.
3. Champion Oncology (Nasdaq: CSBR)
A monster upward trend, with every pullback being bought since mid-April, put this stock on the list. Going long now at $17.00 per share makes technical sense.
4. Denison Mines (AMEX: DNN)
A sub $1.00 per share penny stock whose shares broke above the 50- and 200-day simple moving averages in mid-September and never looked back. Pushing into the $0.68 per share zone, setting buy orders to catch a breakout above 0.70 cents is the play on Denison Mines.
5. DSW Inc. (NYSE: DSW)
A gap higher off the 50-day simple moving average then a higher high after a consolidation paints a very bullish technical picture for DSW. Getting long at $34.00 per share is the suggested entry point.
Risks To Consider: Buying price momentum has inherent risks. The primary threat is the fact that no one knows when the price momentum will end. Next, most institutional and other big money players sell into momentum then buy the weakness. Be sure always to use stop losses when momentum investing!
Action To Take: Consider adding one or more of the above momentum stocks to your portfolio. Start to scan for stocks exhibiting upside momentum and monitor them for buying opportunities.
— David Goodboy
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Source: Street Authority