Many
investors have a negative view of momentum trading. To these skeptics, momentum trading can be
lumped in the same category as trend trading, i.e. seeking out stocks in a
rising trend and simply jumping on board hoping to catch a ride. Such an approach is indeed worthy of
contempt, yet this isn’t what momentum trading is truly all about.
When
done correctly, momentum trading combines the elements of a stock’s price,
internal breadth and even earnings. I
believe true momentum trading can be distilled into four basic principles. In sum, momentum traders seek to discover:
1. A company whose stock’s price is
showing relative strength to the S&P 500 and leadership within its own
industry group.
2. A stock whose industry group is
currently experiencing strong internal momentum (defined as the rate of change
in the net number of new quarterly, or yearly, highs within the group).
3. A stock which has strong forward
earnings and revenue growth prospects.
4. A stock which is already enjoys an
element of forward price momentum.
Amateur
momentum traders would most likely look only at point #4 for identifying
trades. An experienced pro on the other
hand would review all four principles before making a trade.
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