What drives momentum

Momentum moves are triggered by some news. A surprisingly good or bad news often leads to start of a momentum move.

This kind of move can be of many types. But the one news with potentially big impact is earnings news. Earnings have the potential to lead to start of multi month or multi year moves.

Sector is another big catalyst. If a sector move gets going the good , bad and ugly companies in it can make big moves. You will see that in solar stocks currently. There are bubble type momentum bursts in these stocks in last few weeks. If you look at the fundamentals of many of these stocks, you will see that they are terrible and likely to be terrible for foreseeable future. But momentum does not care about it. If a stock has momentum you need to keep all other logic aside and just look at it as trading candidate.

In industries with long order to production or implementation cycle, news of new order can lead to start of big moves. This is also common in project based industries like heavy construction, defense, aerospace and infrastructure.

The biotechs are a class by themselves. There are two types of biotechs in market. The bigger established companies like AMGN, BIIB, CELG, REGN, VRTX and ALXN have real revenue. The second category of biotechs are developmental stage biotech that trade mostly based on expectations of FDA approval or results of clinical trial.

The cyclicals trade based on expectations. They rally ahead of their actual earnings improvement as market participants can anticipate good times. When they have good earnings, they might be about to top. These are deep cyclicals and many of them like coal, shipping, heavy construction commodities can go through multi year boom burst cycle. Currently the commodities are going through burst cycle while 7 or 8 of years ago they were in big secular up trend.

Besides these catalyst there can be many other catalyst like govt policy change, wars, drought, terrorist attacks, disease outbreak and so on. You will see stock moving based on these kind of news if the news is game changer. Post 9/11 the market was closed for many days. Once it opened one small company InVision Technologies, Inc. (INVN was the ticker for it that time. Has been bought subsequently by GE)had a big high volume breakout. That started the big rally for the stock, it went up 100% in few quarters.

When you look at the top 25 stocks by momentum , try and find what was the catalyst at beginning of each of these moves. That way you can build skill to identify a future momentum leader.

Playing Sectors

When you study sectors moves over a period of time, you find some interesting things which again can help you design a better trading system. While most people have generalised knowledge about sector, if you can find sector specific behaviour then you have an edge.

There are always problem with sector based strategies as many new stocks are lumped in to some existing sectors and sector behavior evolves over a period of time. For example many sector grouping services lump the exchanges under business services sector, while they are a category by themselves. So when looking at young stocks I always look at its sector skeptically.

Now having studied earnings and momentum based strategies on sectors, there are couple of unique behaviours you will find which one can factor in to your decision making. Some of these findings are in public domain, but if you do your own studies you would find some sector specific exploitable anomalies. I have found few such anomalies which are not in public domain.

While I do not want to talk about them, some reasonably common knowledge ones are worth studying also. For example the retail sector has a very unique behaviour and your earnings and momentum models need to factor that in. I am perfectly happy to buy a relatively low relative strength retail play as my studies show buying at such juncture is more profitable than buying at high relative strength. Shorting retail sector also is profitable because retail trends generally tend to persist because of the nature of sector where if you get your strategy wrong, it takes lot of time to reverse that. Retail sector also shows predictable calender tendencies.

The technology sector is best for momentum trading. I am perfectly happy to buy a technology play with low earnings , if it has high relative strength. Again this has to do with unique nature of the sector. Biotechs are best bought on catalyst. Most of them will have an intense burst of price activity driven by news. If you chase momentum without catalyst in this sector , many times you end up buying the top as the burst in price is primarily driven by future expectations. Also you seldom find a biotech with good earnings. The biotechs which make 100% plus kind of moves in few months in one single intense burst have no revenue and no earnings.Some sectors are best played using value based strategies.

Some sector anomalies have persistence, while others stop working as more people figure out the same things. . So if you focus on finding sector anomalies, you get a unique perspective which most people randomly chasing chart patterns or indicators or quantitative techniques lack. If you can isolate a sector behaviour, you have an exploitable edge.


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