TSCI Street Pulse - December 8, 2009

Topic: Momentum Trading

Last month I wrote, on a couple of occasions, that a key maxim for successful investing is that “the trend is your friend”. The concept of momentum trading grew out of that, and reached dizzying heights in the latter half of the 1990s with the advent of the now ubitiquous day-trader. Day-trading has caused unprecedented volatility in stock markets ever since.

The development and acceptance of technical analysis has afforded the advantages of identifying stable, repeatable, and predictable stock patterns. This has allowed momentum trading to proliferate.
Momentum trading, essentially, is buying and holding a stock that is going up, for a period that can be days, weeks, or months. This is entirely different from day trading where astute market watchers buy at the beginning of or during the day and sell before the day is over.

Momentum traders try to ride on the coat-tails of a stock exhibiting a rising trend in hopes that the trend will continue.

The following precepts can be used to maximize investment returns by any investor interested in momentum trading:

(1) The stock must be going up for an extended period, at least 4-6 weeks.

(2) Identify companies whose reported earnings have substantially exceeded Street estimates, since these are often the companies whose stocks capitalize on those postive earnings announcements for a long time after.

(3) The Company’s stock should have significant institutional ownership. When purchasing a position, the portfolio managers of investment funds usually accumulate those positions slowly, avoiding the volatility caused by day-traders who move in and out of a stock quickly.

(4) Follow the trend-friend guideline, but be prepared to sell the stock just as soon as the trend changes, because momentum stocks can change direction suddenly.

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Bob Weir, B. Comm, B.Sc., CFA. - eResearch

Mr. Weir has 43 years of investment research and analytical experience in both the equity and fixed-income sectors, and in the commercial real estate industry. He was at Dominion Bond Rating Service (DBRS) from 1994 to 2001, latterly as Executive Vice-President responsible for supervising the firm’s 34 analysts and conducting the day-to-day management affairs of the company. He joined eResearch in 2004 and has been its President, CEO, and Managing Director, Research Services since May 2005.