Momentum stocks, that’s stocks that are trending strongly in either direction, can provide great trading opportunities. We only need to look at the performance of stocks such as Nvidia (see below) over the YTD to confirm that.
Spotting stocks with momentum in the price action might sound quite daunting. However,
traders can use technical analysis to identify both momentum stocks and often the entry and exit points for trades in them.
Traders can identify momentum stocks by analyzing price charts, chart patterns and volumes traded, all of which can help to determine when a stock is building momentum, or if you prefer persistent directional price action, that they can take advantage of.
How can traders screen for momentum stocks?
There are various ways to look for momentum stocks one obvious way is to screen for stocks that have made decent percentage moves over the past week or month.
In the images below we see S&P 500 stocks ranked by their 5-day % change.
Initially, we see them ranked in descending order, that is the largest gainers first, and then in the second table, in ascending order, that is the largest losers first.
Source Barchart.com
In this view, I have also included fields to show 1-month, 3-month, 6-month and YTD % changes. That data provides us with some context and helps us to see at a glance if recent price action has been moving with a pre-existing trend, or counter to it.
For example, Intel (INTC US) has fallen by -10.61% over the last 5 days. A move that’s completely counter to the other performance metrics for the stock, in this table.
What's interesting about Intel's price action is that we initially saw a move higher in the price, and then a classic reversal signal or pattern, in the shape of a shooting star (highlighted in the chart below) that signified a rejection of the new highs, from where it promptly sold off in textbook fashion.
Source: Barchart.com
Volume traded can also be a useful pointer to momentum stocks. The thinking here is that the higher the volume is in a stock, the more genuine and sustainable the move in its price is likely to be.
it also follows that traders should be cautious about large moves in stocks that are not accompanied by higher or larger than average volumes, as they could well be false breakouts.
Upside breakouts should occur on expanding volume which points to accumulation.
By the same token, downside breakdowns should also see a pick-up in selling volume or distribution.
Traders can use volume-based indicators such as the Chaikin Money Flow or On-balance Volume to confirm buying or selling pressure. However, I find that comparing current volumes with average daily volumes can be just as effective at highlighting momentum opportunities.
The Role of Moving Averages
Another way to screen for momentum opportunities is to look for stocks where the price is approaching a moving average.
For example, the 20 or 50-day lines, though for short-term opportunities the 20 and 50-hour MAs can prove to be very effective indicators.
Here is a great example of a stock developing downside momentum, and the roles that the 20 and 50-Day MA lines played in identifying, and confirming the opportunity.
In ellipse 1 on the chart, we see the price of Boeing (BA US) break below the 20-day MA line, in orange, and test towards the 50-day line drawn in green.
Ultimately breaking below the 50-day line before rallying and testing back to the 20-day MA. Where, as we can see in ellipse 2, it failed and sold off once more, breaking back below the 20-Day line, highlighted by ellipse 3.
Subsequently, we saw the 20-day MA line cross down through the slower-moving 50-day line, see elipse 4. That’s known as a dead cross, which is a classic signal of downside momentum and that confirmed the veracity of the move.
As of the time of writing Boeing had lost just under -12.0% in a month.
Source: Barchart.com
Interaction with moving averages can also help to confirm momentum in, and the prevailing direction of a move. For example here is the chart of McDonald's (MCD US ) a stock that I have been following on the downside since mid-August.
I got very interested when McDonalds broke below $286, but before that point, we had seen the price break below the 50-day MA line and the uptrend line, drawn from the mid-March lows. What's more the price tested higher after those breaks.
However, it rejected on a retest of the 50-day line from below and sold off once more, trading down to as low as $266.91 as I type. Having previously broken through the three lines of horizontal support I had drawn on the chart.
Note also that the 50-day line has started to move lower at the same time offering further confirmation of the negative momentum in the stock.
Source: Barchart.com
No such thing as risk-free trade
There are very few if any risk-free trades in the market and it's important to remember that. however, if you can find momentum opportunities that are confirmed by price action and volume then you are slanting the odds of success in a trade in your favour.
Simply because you are following the path of least resistance for that instrument's price the less friction there is in the price action, then the more one side the move in price is likely to be.
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