“Buy low and sell high…”
That simple mantra recited among countless investors is supposed to sum up how investing and trading works. If only it were that easy! After all, “buying the dip” has been a futile exercise so far in 2022.
But what if I told you that there’s a much simpler, better way than trying to time the bottom? It’s a strategy that turns the old mantra on its head, and one that’s been proven to turn out big profits by academics and money managers alike.
It involves targeting a group of select stocks that permeates the world of quantitative and algorithmic trading systems.
Simply put, the better strategy here is to “buy high, and sell higher.”
How to Play Momentum
Last week, I talked about picking stocks based on relative strength. Then I got a question from a subscriber to my Flashpoint Fortunes options newsletter.
The subscriber wanted to know why I don’t buy calls (betting the stock price goes up) at the bottom of a price range. Nor do I buy puts (betting the stock price goes down) at the top of a price range.
It’s a great question! So, I’m going to show you how to measure and use relative strength to your advantage … using what are called momentum factors.
The momentum factor does exactly what the term implies. It favors stocks that have performed the best over a trailing period (typically six to 12 months), while shunning stocks that have performed poorly.
The rationale behind why this works comes down to our own behavioral biases and tendencies. For example, we humans love to chase stocks moving higher over FOMO … or “fear of missing out.” That is what sustains price momentum.
I also find that momentum factors are crucial in keeping you on the right side of the stock market, and can point you to the right industries or sectors.
So instead of trying to time the bottom, why not go with what’s already working?
A Guiding Light
In our recent Big Picture, Big Profits video, I talked with Ted about the potential to see a bear market rally unfold.
When discussing which stocks would be on my short list of buy candidates, I pointed to those showing relative strength and trading near the highs … or demonstrating strong momentum.
And if that bear market rally doesn’t develop, then I’m prepared to add puts on stocks with poor price performance and setting up to crash to new lows.
When I run my momentum scans to search for trade ideas, here are two standouts:
- Positive momentum: CenterPoint Energy (NYSE: CNP).
- Negative momentum: BigCommerce (Nasdaq: BIGC).
And that is how I stay prepared to trade on either side of the stock market. Momentum factors help guide me to the optimal sectors and stocks for trading opportunities … higher or lower.
So, rethink the old mantra and keep the momentum on your side!
Research Analyst, The Bauman Letter