12 Momentum Investing: Capitalizes on trending stocks with strong price momentum and high trading volume.
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12.1 Trend Following
📖 Involves identifying and trading in the direction of prevailing trends in the market.
“Identify Trends”
— Richard D. Wyckoff, The Richard D. Wyckoff Method of Trading and Investing (1931)
Trend following involves identifying the prevailing trend in the market and trading in that direction. Trends can be identified using a variety of technical analysis tools, such as moving averages, trendlines, and support and resistance levels.
“Follow the Trend”
— Jesse Livermore, Reminiscences of a Stock Operator (1923)
Once a trend has been identified, it is important to follow the trend and not try to pick tops and bottoms. Trend following is a disciplined approach to trading that requires patience and discipline.
“Use Stop-Loss Orders”
— William O’Neil, How to Make Money in Stocks (1988)
Stop-loss orders are a critical risk management tool for trend followers. A stop-loss order is an order to sell a stock if it falls below a certain price. This helps to protect profits and limit losses.
“Trade with the Trend”
— John Murphy, Technical Analysis of the Financial Markets (1989)
Trend following is a simple but effective trading strategy that can be used to profit from trending markets. By following the trend and using stop-loss orders, trend followers can protect their profits and limit their losses.
“Identify Breakouts”
— Linda Raschke, Street Smarts: High Probability Short-Term Trading Strategies (1999)
Breakouts are a common trading signal that can be used to identify the start of a new trend. A breakout occurs when a stock price moves above a resistance level or below a support level.
“Use Moving Averages”
— Alexander Elder, Trading for a Living (1993)
Moving averages are a technical analysis tool that can be used to identify trends. A moving average is a line that shows the average price of a stock over a specified period of time.
“Use Trendlines”
— Martin Pring, Technical Analysis Explained (1991)
Trendlines are a technical analysis tool that can be used to identify trends. A trendline is a line that connects two or more price points on a chart.
“Use Support and Resistance Levels”
— J. Welles Wilder, New Concepts in Technical Trading Systems (1978)
Support and resistance levels are technical analysis tools that can be used to identify areas where a stock price is likely to bounce or reverse. Support is a price level below which a stock price is not likely to fall, and resistance is a price level above which a stock price is not likely to rise.
“Use Volume”
— Mark Minervini, Trade Like a Stock Market Wizard (2007)
Volume is a technical analysis tool that can be used to identify the strength of a trend. High volume indicates that there is a lot of interest in a stock, and low volume indicates that there is not much interest in a stock.
“Use Momentum Indicators”
— Ralph Vince, The Mathematics of Money Management (1992)
Momentum indicators are technical analysis tools that can be used to identify stocks that are moving quickly. Momentum indicators can be used to identify stocks that are likely to continue to move in the same direction.
12.2 Relative Strength
📖 Compares the performance of a stock to a benchmark or other stocks to identify those with superior momentum.
“Buy stocks that have outperformed the market over the past 6-12 months.”
— Peter Lynch, One Up on Wall Street (1989)
Stocks that have been trending up in the past are more likely to continue to do so in the future. Look for stocks that have outperformed the market over the past 6-12 months.
“Buy stocks that are breaking out of a trading range.”
— William O’Neil, How to Make Money in Stocks (1988)
A breakout occurs when a stock price moves above a previous high. This can be a sign that the stock is entering a new uptrend. Look for stocks that are breaking out of a trading range, which is a period of consolidation.
“Buy stocks that are trading above their 50-day moving average.”
— Richard Wyckoff, The Wyckoff Method of Stock Market Trading (1931)
The 50-day moving average is a technical indicator that shows the average price of a stock over the past 50 days. A stock that is trading above its 50-day moving average is in an uptrend.
“Buy stocks that have a high relative strength index (RSI).”
— J. Welles Wilder, New Concepts in Technical Trading Systems (1978)
The RSI is a technical indicator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions. A stock with a high RSI is considered overbought and may be due for a correction. Look for stocks with an RSI below 70.
“Buy stocks that are in sectors that are outperforming the market.”
— Martin Zweig, Winning on Wall Street (1986)
Stocks in sectors that are outperforming the market are more likely to continue to do so. Look for stocks in sectors that are benefiting from tailwinds such as technological advancements or changes in consumer behavior.
“Buy stocks that have positive earnings momentum.”
— Kenneth Fisher, The Ten Roads to Riches (2008)
Earnings momentum is a measure of how quickly a company’s earnings are growing. Stocks with positive earnings momentum are more likely to continue to grow their earnings in the future. Look for stocks with earnings that are growing at a faster rate than the market.
“Buy stocks that have strong institutional support.”
— Warren Buffett, The Snowball: Warren Buffett and the Business of Life (2008)
Institutional investors such as mutual funds and pension funds are often considered to be smart money. When they buy a stock, it is a sign that they believe in the company’s long-term prospects. Look for stocks that have a high percentage of institutional ownership.
“Buy stocks that have a low price-to-earnings ratio (P/E).”
— Benjamin Graham, The Intelligent Investor (1949)
The P/E ratio is a measure of how expensive a stock is relative to its earnings. A low P/E ratio can indicate that a stock is undervalued. Look for stocks with a P/E ratio that is below the market average.
“Buy stocks that have a high dividend yield.”
— John Templeton, The Templeton Plan (1992)
Dividend yield is a measure of how much a company pays in dividends relative to its stock price. A high dividend yield can indicate that a stock is undervalued. Look for stocks with a dividend yield that is above the market average.
“Buy stocks that have a strong management team.”
— Peter Drucker, The Practice of Management (1954)
A strong management team can make a big difference in the success of a company. When evaluating a stock, look for companies that have a track record of success and a management team that is respected in the industry.
12.3 Breakout Trading
📖 Focuses on identifying stocks that are breaking out of specific price ranges or patterns, indicating potential for continued momentum.
“Identify Stocks with Strong Recent Performance”
— John Murphy, Technical Analysis of the Financial Markets (1989)
Start by identifying stocks that have exhibited strong price appreciation in the recent past. Look for stocks that have made new highs and have been trending higher for an extended period.
“Look for Volume Confirmation”
— Richard Wyckoff, The Wyckoff Method (1931)
Volume is a critical factor in breakout trading. You want to see a surge in volume as the stock breaks out, as this indicates that there is strong buying interest behind the move.
“Use Support and Resistance Levels”
— Thomas Bulkowski, Encyclopedia of Chart Patterns (2000)
Support and resistance levels can provide important clues about potential breakout points. A breakout above a resistance level or below a support level can signal a change in trend and provide an entry or exit point.
“Identify Chart Patterns”
— Steve Nison, Japanese Candlestick Charting Techniques (1991)
Chart patterns, such as triangles, flags, and pennants, can provide insights into the potential direction of a breakout. Traders can use these patterns to identify potential trading opportunities.
“Set Stop-Loss Orders”
— Alexander Elder, Trading for a Living (1993)
Stop-loss orders are essential for managing risk in breakout trading. They help protect your profits by automatically selling your stock if the price falls below a certain level.
“Use a Trading Plan”
— Mark Douglas, Trading in the Zone (1990)
Having a trading plan is crucial for success in breakout trading. Your plan should outline your entry and exit strategies, as well as your risk management parameters.
“Be Patient”
— Warren Buffett, The Intelligent Investor (1949)
Breakout trading requires patience. Sometimes, stocks will take their time to break out of their ranges. It’s important to be patient and wait for the right opportunity to enter a trade.
“Manage Your Risk”
— Nassim Taleb, Fooled by Randomness (2001)
Risk management is paramount in breakout trading. Never risk more money than you can afford to lose, and always use stop-loss orders to protect your capital.
“Learn from Your Mistakes”
— Peter Lynch, One Up on Wall Street (1989)
Mistakes are a part of breakout trading. The important thing is to learn from your mistakes and adjust your strategy accordingly.
“Stay Disciplined”
— Jesse Livermore, Reminiscences of a Stock Operator (1923)
Discipline is essential for successful breakout trading. Stick to your trading plan and don’t let emotions get in the way of your decision-making.
12.4 Volume-Based Momentum
📖 Utilizes trading volume as a key indicator of momentum, with higher volume suggesting increased market interest and potential for price appreciation.
“Identify stocks with consistently high trading volume relative to their average historical volume.”
— Technical Analysis, Inc., Technical Analysis of Stocks, Commodities, and Bonds (1948)
High volume indicates strong market interest, suggesting that a trend is likely to continue. Consistently high volume provides confirmation of ongoing momentum.
“Look for stocks with increasing volume on up days and decreasing volume on down days.”
— Martin Pring, Technical Analysis Explained (1985)
Volume should confirm the price trend. Increasing volume on up days shows buying pressure, while decreasing volume on down days indicates a lack of selling pressure.
“Use volume-weighted average price (VWAP) to determine the average price paid per share over a specific period.”
— John Bollinger, Bollinger on Bollinger Bands (2001)
VWAP considers both price and volume, providing a more accurate representation of the average price of a stock compared to simple moving averages.
“Combine volume analysis with other technical indicators, such as moving averages or support and resistance levels.”
— Tushar Chande, The New Technical Trader (1994)
Volume analysis can be enhanced by considering other technical indicators. This helps identify potential trading opportunities and confirm market trends.
“Use volume to identify potential breakouts or reversals in stock prices.”
— Steve Nison, Japanese Candlestick Charting Techniques (1991)
Volume can provide insights into potential price movements. High volume on breakouts suggests momentum, while low volume on reversals indicates a lack of conviction.
“Consider the relationship between volume and volatility.”
— Mark Douglas, Trading in the Zone (1990)
Volume and volatility are related. High volume during periods of low volatility can indicate accumulation or distribution, while low volume during periods of high volatility can suggest a lack of conviction.
“Use volume to identify potential overbought or oversold conditions.”
— Larry Williams, Volume Indicators (1979)
Extreme volume levels can indicate overbought or oversold conditions. High volume on declining prices may suggest selling pressure, while high volume on rising prices may indicate buying pressure.
“Look for stocks with rising volume and relative strength.”
— William O’Neil, How to Make Money in Stocks (1988)
Rising volume combined with relative strength, measured by price performance against a benchmark, can identify stocks with strong momentum.
“Use volume to identify potential trend reversals.”
— Richard Wyckoff, The Richard D. Wyckoff Method of Trading and Investing in Stocks (1931)
Volume can provide clues about potential trend reversals. A sudden increase in volume on a down day can indicate buying interest, while a sharp decline in volume on an up day can suggest selling pressure.
“Consider volume when making investment decisions, but also use other factors for confirmation.”
— Warren Buffett, The Intelligent Investor (1949)
Volume is an important factor, but it should not be used in isolation. Combining volume analysis with other fundamental and technical factors can provide a more comprehensive view of a stock’s momentum and potential.