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Spotting Super-Momentum Stock Trades

03/23/11 03:43:13 PM
by Billy Williams

The ability to pick a winning momentum stock or an emerging stock leader is often built upon hours of tireless searching through stock charts, but there is an easier way.

Security:   NILE, BSFT
Position:   Buy

Entering a position in the strongest stocks in the market gives you the opportunity to maximize both the principles of momentum and velocity for maximum gains. It is hard to argue that catching an emerging leader is one of the most coveted and sought-after stock picks among traders, because by doing so, there is both a windfall of huge gains and the special pride of having picked a super-performer out of a universe of stocks. Yes, it involves hours of tireless searching through stock charts, scanning through a universe of price action and a solid understanding of fundamentals, but there is a simple pattern that can help you spot a high-performer for solid gains.

FIGURE 1: NILE. NILE bottomed in August 2006, then rose rapidly by more than 50% inside just a few weeks. This showed enormous momentum building up, which caused NILE to gain more than 120% over the next several months.
Graphic provided by:
Momentum stocks are predicated on using a model to filter out poor performers in order to find stocks with runaway characteristics. A typical momentum model is a combination of fundamentals and technical analysis. See Figure 1.

On the fundamental side, you want to factor in sales growth and earnings, which are the lifeblood of Wall Street. Floor traders and institutional traders watch earnings reports like hawks during each quarter while scanning for any signs of potential weakness in order to determine future prospects for a stock. In addition, return on equity, return on income, quarter over quarter growth, new products that were released, debt-to-income ratio, and more are often used to weed out potentially underperforming stocks in favor of stocks that have greater future prospects.

On the technical side, you want to factor relative strength rankings with an emphasis on the high side, trading at or near all-time highs, increasing trade volume, bullish chart patterns, and other related technical methods to determine the emergence of a strong trend with lots of upside potential.

However, while all of these methods are valid, there is one pattern that has revealed several emerging high-performers with lots of upside potential, and that is a stock that has made high-percentage gains in a short span of time. See Figure 2.

FIGURE 2: BSFT. Currently, BSFT has experienced both a breakout and a rapid increase in share price, which suggests that the stock is under heavy accumulation and building momentum to go even higher from its current price levels.
Graphic provided by:
Look for a stock to make a quick gain of 50% or more during a six- to eight-week time frame. The momentum generated is typically the result of a big investor or institutional trader that has strong regard for its future prospects and has taken a significant position. The resulting rise in the share's stock price attracts both floor and retail traders who get caught up in the frenzy of buying and don't want to be left out.

Often, the rapid rise in share price is followed by a pause in the stock's ascent as traders who have taken a position are sitting tight and traders on the sidelines are hesitant about getting in at the higher price value and adopt a wait-and-see attitude to see what materializes next.

Now, one of two things can happen after an appropriate waiting time. One is that some positive news emerges either in the form of earning surprises, approval of a new patent, or a revolutionary product launch, which acts as a catalyst that causes an explosion in price value. Another is that more traders take a larger position in the stock, which acts as a catalyst in and of itself.

The following move could result in enormous gains as long as you are patiently waiting for the right time to enter the move and you respect the risk involved in trading the stock, protecting yourself at all times with stop-loss orders and not overexposing yourself to a position that is too large.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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Date: 03/30/11Rank: 1Comment: 

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