Embrace the Momentum Trader Within

Over the years, I have encountered, personally explored, taught and shunned more styles than I care to admit. I’ve day traded, swing traded and everything in between. However, thankfully over the years, I’ve been able to piece together the style that fits me. In my book, I go into an in-depth look at making sure that your style correlates with your personality and how important this is in order to succeed. I won’t rehash what is readily available to all, however, one area I failed to explore in the book was the actual type of stocks that one trades. The assumption is made that the style presented can be applied to any stocks, over any time period. While this is true, it is similar to saying that there are many styles of trading that work…choose one and move on. Unfortunately, I failed to explore the type of stocks available to trade and how these stocks also make up a trader’s DNA. In one of the best trading books ever penned, Trading in the Zone, Mark Douglas discusses the psychological shaping of a child when a past experience dictates their view of the future. In the work, he specifically discusses how a young child encountering a dog for the first time will have his entire outlook of dogs shaped by this one experience. For instance, if the dog is barking wildly and maybe even takes a snip at the boy, odds favor the child developing a fear of dogs due to his association with this one experience. On the other hand, if the child has a pleasant experience, odds favor a positive association with our four-legged friends. This makes me wonder why my son is petrified of industrial-strength toilets in rest stops. Hmm…but I digress.

Most traders, at some point in their life, have an experience with a variety of different stocks. Odds are that a person’s first-ever trade was a blue chip company, seeking to simply buy low and sell high. Also, at some point, a trader may have had an experience with a small cap, thinly-traded issue or regardless of the market cap, a momentum name. Based on the character of the stock in question at the time of our involvement we will tend to associate the movement with the category. For example, if I own General Electric (GE) for six months watching it move within a 3% range, I’m going to surmise that blue chips are slow to move and boring. On the other hand, if I snatch up a Uranez Energy Corporation (URZ) as I did yesterday and subsequently realize almost a 12% return within a few hours, I’m going to categorize the momentum group as high flying and volatile.

What’s on your MP3 Player? Oh, don’t have one? OK, what stations are programmed into your car stereo? Why do I ask? Well, this will often times give you a great indication of the stocks that fit your personality. Fixated on the constellations? Well odds are, ‘slow and large’ are for you. Classical music all the way? Yup, definitely the more predictable in nature with a small slice of momentum for the occasional crescendos in life. I’m a salad bar kinda guy. You see, in my MP3 player or car stereo I have it all. There’s nothing I love more than a little World Report or Car Talk from NPR. However, only one dial over is K-Love, a Christian Radio station. Next to this is classic rock where I’ll always keep an ear out for a little George Thorogood or Led Zeppelin. The last two buttons? Oh well, R&B followed but Thugged-Out Gangsta Rap, of course. Hey, don’t judge! In short, depending on the mood I’m in, dictates the type of music I’ll listen to.

But here’s the big question. Who wouldn’t want a 12% mover in one day? Why would anyone on earth settle for an Intel Corporation (INTC) when they could have an Anadigics (ANAD)? Are there those out there with blue chip personalities, playing hip hop type stocks? You bet there are and I know many, personally. Connie Corbett, a dear friend and Tickerville member, is the consummate gentleman. Of course, this doesn’t mean that momentum or small cap traders are not gentleman but you get the point. Connie is a Winegrower by trade, a skywatcher and classical music lover, a cook and has an incredible knowledge of Woody Allen movies. Want to take a guess at what type of stocks Connie trades? Closed Fund, Dividend-producing ETFs you say? Nope, not even close. Connie trades uber-momentum. Whereas, I would have a hard time playing a sub-100k-share-traded issue, Connie embraces it.

So is Connie the exception to the rule? Or is Connie playing where he shouldn’t?

It is my belief that Connie has struck a balance, understanding his style and molding it to his personality all the while playing the stocks that can actually reward him sooner than next year. You see, it is my belief that not a single person if asked would opt for 12% in a few months over 12% in a few hours. The problem is the association that we make with these stocks due to our past experiences with them.

Like a bad church experience that taints a person’s view of organized religion, at some point my guess is most traders venturing into the world of small caps or momentum stocks have been burned and burned good. As the old saying goes, ‘fool me once shame on you, fool me twice, shame on me.’ I believe most natural and educated reactions are simply to avoid the group altogether. I have seen this time and time and time again but it typically plays out in a variety of different ways.

Many will simply avoid the group, sticking only with large, liquid names. They feel much better about losing their money slowly and over time and therefore it takes many months if not years to return to the same conclusion that possibly their execution and/or entire strategy are the issue for their lack of progress. Others have the game down well and understand that they need volatility to make money. These calculated thrill seekers will usually gravitate to the Emini S&P contract or ‘ES’ as it is commonly referred to. Others will adopt the leveraged ETFs looking to avoid individual company ‘surprises’ all the while exposing themselves to something that actually moves.

However, I feel strongly that there is a middle ground worth exploring. If you have a solid strategy that gives you your edge, be it pattern recognition or the like, understand quantifiable risk and possess a profit-taking strategy, why not embrace the volatility of key individual stocks with a much larger leash and therefore a longer time frame?

Let’s take Merge Technologies (MRGE) for a moment. If you pull up this chart you will see a recent 30% move followed by consolidation. Yesterday, this stock moved higher by 2% and still didn’t really find any legs. A breakout here would be nothing short of a 10% move and then some. When reviewing a stock like this most will immediately be reminded of past momentum failures. A quick 10% rinse or a 15% correction is entirely possible and therefore something to definitely cringe at. However, what if you pull back this chart quite a bit. In fact, bring back the chart all the way to 2009 and notice the longer-term consolidation from the July 2009 peak. Notably, the $1.00 move doesn’t look so daunting does it? However, if this is now breaking from a two-year pennant, is the same $1.00 as a stop too far away? Considering that a move to recent highs would be $1.00 away ($4 to $5) a real break out of this pattern could yield another $2 or even $3. Meaning, that to risk $1.00 while attempting to gain $4 or $5 is an excellent risk to reward. Ah, but a $1.00 stop on a $4.00 stock is a bit ridiculous, right? Wrong. The $1.00 stop is well within the confines of the movement here and probably conservative.

Now, many of you who trade with me in Tickerville each day are saying “Didn’t you just take that with a .15 stop?” and the answer is yes, however, I did so to try and capitalize on a very, very quick move and not to play the larger pattern in question. A better example may be the Uranez Energy (URZ) discussed earlier and the fact that upon entry, my stop was placed at $2.50 or over 30% from where it closed yesterday. Too far? Not when the stock has the potential to move double digits in a few hours.

In summary, if you find yourself with a past experience that taints your view of momentum or small caps, I strongly suggest that rather than shunning this group altogether, you seek to swing these names with a purpose. Move into a name that has the potential to move but do so with a plan that keeps you in during a normal shake. Take the position in a method that does not require you to sit in front of the computer for eight hours straight. Take the position so that you can actually stay in for a huge run.

For the first time in years, momentum is working in a big way. Stocks are trending and despite the shakes back and forth, many are offering excellent opportunities for those with a plan and an edge. Embrace these opportunities and let them work. Blend a little Hip Hop with your Mozart!

At the time of this writing Quint was long URZ and MRGE