The Investment U E-Letter: Issue # 191
Thursday, November 21, 2002 Momentum Stock Trading System: How One Investor Made 1,379% in Three Years by Copying an Investment System
By Dr. Steve Sjuggerud, Chairman, Investment U
At first glance, investing in momentum stocks using a trading system sure looks like a dumb idea…
"I'll catch this stock while it's going up and ride it, and then get off in time." Who can possibly do that with consistency? Think about it… that assumes that you KNOW the stock is DEFINITELY going up… It assumes that you'll KNOW exactly when to get out before the music stops. And it assumes that when that day comes, you will ACTUALLY sell, and not hang on and get greedy for more. My goodness, that's a lot of assumptions. I want as few assumptions as possible when it comes to investing. I want as much certainty as I can get, and ride its momentum. For example, one stock I'm recommending, D.R. Horton, has a $2.8 billion sales backlog right now. For Horton, that means the next six months of sales are already certain. The stock is certainly super-cheap (at a P/E of 6). And all they own is earth and homes in America, so I'm certain that there's some value there. And there are no real "intangible assets" on the books. What you see is what you get. I can still lose money of course. But at least I know what I'm investing in, instead of jumping on any random trend just because it's going up. How You Can Use Momentum Stock Trading To Get The Best Of All Worlds So as you can tell, I'm not an advocate of the basic "price-chasing" type of momentum stock trades, in particular for individual investors. It's popular, but it just doesn't make any sense. Besides, how many folks on the list of the world's richest people are momentum investors? The answer is "none." However, you can combine momentum with other factors to create something useful and profitable in your investing strategy. For instance, if you combine value with price action (momentum), you may just get the best of all worlds… As an example, at around $18 now (as of November 2002), Horton might be a great value. Of course, it was a good value when it was $25 a few months ago as well. And it will be an even better value at $10 a year from now. And a steal at $5 in two years, and at zero… wait a minute! Now you can see the problem with "value" investing. Contrary to what "value guys" preach, a falling price is not a good thing. It means you're losing money. Somebody needs to remind these guys that you want your investments to go up. There are an extraordinary number of values out there, as the market has fallen over the last 2 ½ years. But they may become even greater values (that's "value guy" talk for "they may fall more") in the next two years. You don't want dead money, waiting for a recovery that may never come. You want to be making money… A Momentum Stock Trading System One Man Followed To A Return Of 1,379% So when is the right time to buy? When the stock is a good value, and when the stock price is just starting to move. The person who has defined this strategy the most clearly and has achieved the most widespread acceptance is William O'Neil. He wrote the best seller, How to Make Money in Stocks, and it is a decent book. Most importantly, it describes his investment system that combines value and price action (he calls it "CANSLIM," I'll share more on it below). And he created the only "other" investment newspaper, The Investor's Business Daily, which helps you follow his system. Also a decent publication. But can someone really follow a system like O'Neil and make a mint? Actually, yes… consider the case of David Ryan, who was interviewed in the 1989 book Market Wizards. With a return of 161% in 1985, Ryan won the U.S. Investing Championship that year. Ryan re-entered in 1986, and won again, with a 160% return. In 1987, he won yet again, with another triple digit year. For the three years, his compounded return was 1,379%. How did he do it? He says in the book, by: "…using O'Neil's criteria for stock selection and being as disciplined as possible. The more disciplined you can get, the better you are going to do in the market. The more you listen to tips and rumors, the more money you're likely to lose." Ryan describes his selection process… "To sum it up, I'm looking for the strongest stocks in the market, in terms of both earnings and the technical picture (momentum investing)." But if Ryan is using the momentum stock trading system, how does he avoid the big crash when everybody bails out? "I cut losers very quickly. The maximum loss I allow is 7%… I make my money on the few stocks a year that double and triple in price. The profits in those trades easily make up for all the small losers." But will this momentum trading system always work? David Ryan says, "Yes, the same types of stocks work time after time. It hasn't changed at all. We can take one of the greatest winning stocks from 1960 and line it up with one of the best stocks in 1980 and they are going to have exactly the same characteristics." Those are big words. But at its core, it makes sense. Buy companies with good fundamentals (showing sound earnings growth) that are now moving up in price. And how do you avoid sinking ships? Don't buy stocks that have been falling in price recently and are hitting new lows. Trying to catch a falling knife is dangerous. Waiting for it to hit the floor and letting it settle before you pick it up… now that's plain smart. Today's IU Crib Sheet - In sum, I think looking at share price action alone - your basic "momentum stock trading" strategy - is dangerous. And dumb, actually. But combining company fundamentals with price action is smart, as it keeps you in quality companies that are moving up in price.
- If you're looking for "action" and want an expert in this area to give you the very best recommendations, I highly recommend you consider The Momentum Alert service, by one of my stock market mentors - C. Alexander Green. His Momentum Alert has locked in short-term, double-digit profits on a regular basis, using a systematic approach very similar to what William O'Neil and David Ryan do. Learn more about The Momentum Alert.
Good investing, Steve Return to Archives
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