Given that baseball season has just gotten under way, we thought it a good time to make use of the old adage that “batters love to swing at the high fastball.” The problem is that it is nearly impossible to hit. Far away from the plate, the ball appears to be in the strike zone, coming in right down the middle—easy to see and easy to hit. However, just when you’ve begun to swing the bat, when it’s usually too late to take a good cut and too late to hold up, the ball seemingly rises and accelerates as it approaches the plate. It’s feast or famine. If you stay with the pitch and take that strong cut you may hit it a mile. However, more often than not, you swing under the pitch and hear the umpire yell “strike.”
Momentum stocks are much like the high fastball. Every day, they seem to rise in price. Revenue and earnings growth are accelerating. The chart looks perfect. The investment community touts the company as the next Apple Computer or Microsoft. Even the media is jumping on the bandwagon. It’s a can’t-miss situation—or is it? More often than not, on a fundamental basis, momentum stocks are extremely overvalued with historical and projected earnings not nearly sufficient enough to justify the current stock price. Quite often, momentum stocks collapse under their own weight, taking down the inexperienced investor with them.
At the current time, some good examples of momentum stocks include electric-car manufacturer Tesla (TSLA), streaming video company Netflix (NFLX), and GW Pharma (GWPH).
Considerations for the chase
If you want to chase these “high fastballs,” here are some recommendations.
• Never be the first one to arrive the party or the last to leave. Invest after it appears as if the momentum or upswing has begun but not after it has become parabolic.
• Maintain discipline. Just as an astute investor attempts to purchase a stock at the appropriate time, he/she should have an exit strategy or a price point on the downside when willing to sell if things don’t work out. Moreover, should you be fortunate enough to have invested and seen the share price move higher, move up the price point at which you are willing to sell. However, don’t place this order too close to the price where the security is currently trading. Give it a little room. Furthermore, once the security has appreciated a specific percent that has been predetermined, sell half and let the other half play out a bit. That way, should the shares reverse and head downward, you only have one-half of your money still at risk.
• Watch for saturation points. All momentum stocks eventually reach their saturation point—the point at which momentum investors begin to exit—creating a vacuum as other types of investors are unwilling to take up the slack. Keep a close eye on this. Generally, you will see the upside begin to slow, volume on up-days dry up while volume on down days accelerates, and key technical levels such as the 50- and 200-day moving averages be breached.
• Don’t forget that news can be released overnight. Bad news released by a momentum-type company will crush the stock price. Be careful about holding more than a couple of a percent of your portfolio in this type of investment and keep an eye on scheduled news releases such as corporate earnings.
• Be aware that momentum cuts both ways. Downside momentum can be just as vicious and swift as upside momentum. Hope is not a strategy. Don’t be a hero. Once the stock price begins to move against you in this type of investment, be quick to cut your losses.
Although it can be rewarding, momentum investing is certainly not for everybody. However, it you think it’s for you, take into consideration what is written above.
Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio.
To contact Fagan Associates, please call 279.1044.