Batters love to hate the high fastball.
Heading to the plate, the ball appears to be in the strike zone, right down the middle – easy to see and easy to hit. However, like a siren luring a sailor to his demise, just when a hitter’s begun to swing his 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 the ball 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 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 inexperienced investors with them.
Current momentum stocks include Zoom (ZM), plant-based meat product manufacturer/distributor Beyond Meat (BYND), cloud-based platform company Twilio (TWLO), and Fastly (FSLY). Since the start of the pandemic more have been popping-up every day.
If you’re tempted to chase these “high fastballs,” here are some recommendations:
1) Don’t be the first one to arrive the party or the last to leave. Invest after it appears the momentum or upswing has begun but not after it has become parabolic.
2) Maintain discipline. Astute investors attempt to purchase stocks at the appropriate time. They should have an exit strategy — a price point on the downside at which they are willing to sell if things don’t work out. Consider yourself fortunate 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 the order too close to the price where the security is currently trading.
3) Give it a little room. Once the security has appreciated a predetermined percentage, sell half and let the other half play out a bit. That way, should the shares reverse and head downward, you only have half of your money still at risk.
4) All momentum stocks eventually reach their saturation point, the point at which momentum investors begin to exit. This creates a vacuum, and 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 accelerate and key technical levels — such as the 50- and 200-day moving averages — be breached.
5) Don’t forget 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 small of a percent of your portfolio in this type of investment. Keep an eye on scheduled news releases, such as corporate earnings.
6) Finally, be aware that momentum cuts both ways. Downside momentum can be just a vicious and swift as upside momentum. Hope is not a strategy. Don’t be a hero. Once the stock prices 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. If you think it’s for you, this advise will help.
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 call (518) 279-1044.
