The WorldlyInvestor Guide to Beating the Market: Beat the Pros at Their Own Game

The WorldlyInvestor Guide to Beating the Market: Beat the Pros at Their Own Game

by Ben Warwick

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Overview

Ten proven strategies for market-beating returns from the leading online source of financial analysis and insight
Learn how to make smarter and more profitable investment decisions from The worldlyinvestor.com Guide to Beating the Market. With today's advances in the Internet and the steadily decreasing costs of trading, it might actually be easier for the individual investor to outperform seasoned investment pros at their own game. But, with the huge number of investment choices and all the conflicting advice out there, where should the small investor turn? This book offers ten simple, highly effective strategies to beat the market and the professionals. The Guide shows you:
o Why a "buy-and-hold" mutual fund strategy may only benefit fund operators
o New ways to trade value, growth, and momentum stocks
o A simple mutual fund trading strategy that has earned 15% per year with minuscule risk
o How to trade exchange traded funds for maximum profit

Product Details

ISBN-13: 9780471394266
Publisher: Wiley
Publication date: 01/31/2001
Series: Worldly Investor Guide to Ser.
Pages: 288
Product dimensions: 6.36(w) x 9.47(h) x 1.08(d)

About the Author

BEN WARWICK is the Market View columnist for worldlyinvestor.com and Chief Investment Officer of Sovereign Wealth Management, Inc., a registered investment advisor that employs sophisticated wealth management strategies on behalf of institutional and high-net-worth families throughout the United States. His previous books include Searching for Alpha: The Quest for Exceptional Investment Performance (Wiley 2000); The Futures Game; The Handbook of Managed Futures; and Event Trading. Mr. Warwick received his BS degree in Chemical Engineering from the University of Florida and his MBA from the University of North Carolina.
WORLDLYINVESTOR.COM, a global financial information and analysis Web site rated as one of the best on the Web by Forbes, Fortune, Money, Barron's, Business Week, and Online Investor, provides news and analysis for the individual investor. One of the few sites to cover all markets around the world, worldlyinvestor.com also offers users a portfolio of newsletters. Worldlyinvestor.com is distributed on Yahoo!, Go Network, Lycos.com, xoom.com, Geocities.com, Ziff-Davis Interactive Investor, Planet Direct, and Raging Bull, among others.

Read an Excerpt

Note: The Figures and/or Tables mentioned in this chapter do not appear on the web.

CHAPTER 1
Momentum Stocks for the Short Run

Be courageous and steady to the Laws and you cannot fail.
--Sir Isaac Newton

Sir Isaac Newton is universally regarded as one of the most influential scientist who ever lived. Among his better-known accomplishments are the discovery of gravity, the invention of calculus, and the construction of the first reflecting telescope. Little did he know that one of his most famous discoveries--now referred to as Newton's Laws of Motion--would someday become the basis for a popular investment strategy.

DEFINING MOMENTUM

Newton's First Law of Motion is commonly known as the Law of Inertia (or momentum):

    I. An object [stock] in motion [in an uptrend] tends to remain in motion [in an uptrend], and an object [stock] at rest [underperforming] tends to remain at rest [underperforming], unless an external force is applied to it.

Momentum is certainly a familiar concept to many. Political candidates, for example, are said to have momentum if they are able to leverage one victory into a string of successes. The term is also common to sport aficionados. And perhaps no other sport captures the true definition of momentum as well as football.

The Denver Broncos are a case in point. After losing at home against the Jacksonville Jaguars in a 1996 play-off game, the Broncos were determined the following year to bring Super Bowl glory to their much-beleaguered hometown. After cruising through the 1997 regular season with an 12-4 record, the team went onto beat the Green Bay Packers 31-24 in Super Bowl XXXII. At this point, the Broncos had a head of steam--real momentum--on their side.

Before the 1998 regular season, the Broncos were heavily favored to repeat as world champions. True to form, the Broncos won their first 13 regular-season games--again, serious momentum. After a few close losses (notably against the New York Giants and Miami Dolphins late in the season), the Broncos did what every good team with momentum is able to do--get back on a winning streak. After avenging their loss against the Jaguars in Denver two years before, the Broncos came to Super Bowl XXXIII with one goal in mind--to beat the Atlanta Falcons and keep the crown in Cow Town. Thus, the Broncos became the seventh team in National Football League history to win back-to-back championships.

Considering the implicit logic of momentum--a concept that is readily observed not only in the natural world but also in the realms of politics and sports--it should come as no surprise that the idea has filtered its way into the field of investment management. Similar to a fan's attraction to a winning team, traders are captivated by stocks whose prices rise more than other stocks around them. And considering the rather selective market rallies of the past few years, what might seem to work in theory actually has some merit in practice.

The year 1999 is a case in point. Although the S&P 500 index gained an impressive 21 percent, nearly one-half of the stocks in the index registered a loss for the year. Those who found themselves invested in the wrong sector underperformed the broad market indexes or even lost money for the year. Yet, if one had invested in the seven stocks with the most price momentum in early 1999, one would have earned over 180 percent. As Figure 1. 1 shows, these seven issues contributed almost 50 percent of the entire return of the S&P 500 index in 1999.

Considering the computing power of the average private stock trader, the accessibility of price information on the Internet, and the seemingly endless rhetoric about momentum stocks on cable television, it is no wonder that the momentum concept is a sizzling-hot investment craze. Giddy day traders and desperate mutual fund managers are not the only ones interested in the momentum approach. Academic researchers, who have been forced to admit that the method has some merit, have also entered the fray. Numerous studies have shown that issues that exhibit price momentum tend to do well in future periods--better than the stock market as a whole, and better than stocks in similar industry groups.

Biggest Contributors to Performance in the S& P 500 Index, 1999

*Qualcomm's return is from its inclusion in the S& P 500 index (July 22, 1999).

FIGURE 1.1 The biggest gainers in the S&P 500 index for 1999. Not surprisingly, six of the seven companies are technology-related stocks.

While the existence of momentum in stock returns does not seem to be too controversial, it is much less clear what might be driving it. Many believe that the effect is due to the relatively slow dissemination of firm-specific news to the investing public. If this is the case, stocks with low analyst coverage (i.e., stocks that are not readily followed by Wall Street analysts) should exhibit more price momentum than, say, IBM or Philip Morris (i.e., companies that are heavily followed by the Street). Indeed, this seems to be the case--profits derived from momemtum-based strategies have been shown to be roughly 60 percent greater among the one-third of stocks with the lowest analyst coverage, compared to the one-third of stocks with the highest analyst coverage (Figure 1. 2).

    The Growing Popularity of the Internet
    The U. S. Internet population was estimated at 100 million in 1999. International Data Corp. forecasts that number will grow to 180 million over the next four years.

But it takes more than a string of unappreciated good news on a company to make it a momentum stock. That is where Newton's Second Law comes into play.

VOLUME AND PRICE

    II. There is a clear relationship between an object's mass [a stock's price], its acceleration [its price momentum], and the force applied to it [a stocks trading volume].
    Analyst Coverage Varies Widely by Firm
    Computer juggernaut IBM has 24 analysts covering it, while B2B (business-to-business) firm IntraNet, Inc. is followed by only five analysts.

In order for a stock to exhibit serious price momentum, it has to attract heavy trading volume. As an example, we will examine the stock of Qualcomm as it slowly morphed from an underfollowed value stock to a momentum stock.

Qualcomm (QCOM: Nasdaq), the wireless telecommunications company, might well be remembered as one of the greatest technology stocks of the 1990s. But this was not always the case. In fact, there were times in October 1998 when the stock was trading below its levels of 1993.

But a lot can happen in a year. QCOM posted an astounding 2,619 percent gain for 1999. Seemingly overnight, Qualcomm was a $100 billion company. The rally was even more stunning when one considers that the stock was not a red-hot IPO (initial public offering), and had not even introduced a breakthrough technology during the year. But when one studies the rise to fame of the company, it will become apparent that it shares many of the characteristics of other great momentum stocks.

As Figure 1.3 shows, Qualcomm was no overnight success. In fact, the company had been a player in the communications technology industry since 1985. The following are some of the milestones and other corporate events that transformed QCOM from a sleepy issue into the best-performing stock in the S&P500 index.

    1. 1/98--Qualcomm announces earnings that exceed Wall Street expectations.
    2. 4/98--Company again reports surprisingly strong earnings.
    3. 7/98--QCOM reports record earnings.
    4. 11/98--QCOM forms WirelessKnowledge with Microsoft; reports record earnings.
    5. 12/98--QCOM again reports record earnings. The company boasts a five-year growth rate of 30 percent per year, yet the company's price-to-earnings ratio (23) and price-to-sales ratio (1. 0) remain at the bottom of the telecommunications industry. QCOM announces layoff of 700 employees. The company's stock price is below its intrinsic value, making QCOM a value stock.
    6. 1/99--QCOM reports earnings that exceed Wall Street estimates.
    7. 3/99--European giant Ericsson agrees to support QCOM's CDMA (code division multiple access), a cellular communications standard. Stock rises from $6.41 at the beginning of 1999 to $10.27.
    8. 4/99--Stock now trading at $21. 77. Trading volume peaks at 250,000 shares per day from less than 100,000 shares. QCOM begins to attract momentum traders; stock is now up 240 percent for 1999.
    9. 6/99--QCOM announces that it will top earnings expectations.
    10. 7/99--CDMA takes the lead as the dominant digital wireless standard for the first time.
    11. 7/99--QCOM stock added to the S&P 500 index; company reports earnings that exceed Wall Street estimates.
    12. 9/99--Wall Street analysts lower rating on QCOM, citing "pinched" margins due to competition from Nokia and Motorola.
    13. 10/99--QCOM stock shakes off lowered ratings, reaches all-time high.
    14. 11/99--QCOM CEO Irwin Jacobs announces that the company will top earnings estimates for the sixth consecutive quarter; stock splits 4:1.
    15. 12/99--QCOM ends the year up 2,619 percent; is best-performing stock in the S&P 500 index.
    16. 1/00--QCOM earnings exceed Wall Street estimates.
    17. 2/00--QCOM stock drops 35 percent from high in 1999. Price-earnings ratio of QCOM is now 126, up from 23 in late 1998.

As we can see from this list, the most obvious attribute of Qualcomm is its consistent earnings history. In the two-year period shown on Figure 1. 3, the company reported record profits 10 times!

This is a crucial element of a momentum stock. Eventually, Wall Street analysts are forced to put companies like these on their radar screens. As analyst coverage increases for these stocks, consistent earnings performance garners more and more attention from large institutional investors and sophisticated private traders. The result is frequently a marked increase in trading volume and a spectacular run-up in share price.

This can even happen before the company actually earns a profit. A distinguishing characteristic of momentum stocks is not record earnings, but earnings that are consistently better than consensus estimates.

One example of this is Domtar, a Canadian forest products company. Domtar management embarked on a plan of adding share-holder value and dumped some unsuccessful business lines. The company then positioned itself to be the low-cost producer in its industry. Although these changes were made in a negative operating environment, they precipitated a number of positive earnings surprises (Wall Street parlance for earnings releases that exceed analysts' expectations). Analysts became increasingly comfortable with Domtar's growth and revised their estimates higher.

Because Domtar (DTC) does not boast a long-term track record of earnings growth or profitability, strict growth investors may not have selected it for their portfolios. But it seems to have been a good choice for momentum investors (Figure 1. 4).

TWO KINDS OF TRADERS

In order for QCOM to evolve from unloved value issue to hot momentum stock, two distinct types of market participants were involved--the news watchers and the momentum traders.

The first movers of the market are the news watchers. These traders typically use a fundamental approach to stock picking--meaning that they primarily consider a company's revenue growth, market share, and other financial data in deciding what to buy and sell. News watchers continuously scan the Internet, Wall Street analyst reports, and other media in order to assimilate as much company-specific data as possible. One of their most important considerations is a company's quarterly earnings announcement. When a company reports earnings that are much higher than Wall Street expects, news watchers act quickly and buy those issues, because higher earnings usually translate into higher stock prices.

The ability to gather breaking news varies among news watchers. Although some are quick to gather and assimilate news, others require more time to analyze the implications of such information. As a result, when only news watchers are active, prices adjust slowly to new information--that is, stock prices underreact.

This gradual diffusion of information is a key component in the role of the news watchers. In the case of Qualcomm stock, a string of strong earnings reports was met with a collective yawn on Wall Street. Even after six positive earnings surprises, QCOM barely budged. In order for a stock to really surge, momentum traders must get into the action.

The most distinguishing characteristic of momentum traders is the type of information they use to make their investment decisions. Whereas the news watchers consider only fundamental information in their decision-making process, momentum traders buy basal on price action. Fundamental information is typically not considered by momentum traders.

Momentum traders became a factor in QCOM's rise at about Point 7 on Figure 1. 3. It was the stock's rise from $6.41 to $10.27 that got the momentum traders' attention, and not the fundamental reason why that occurred. This group of traders buys stocks simply because they are rising; they feel that the rising stock price must be occurring because the prospects for the company are improving.

And, as Point 7 on Figure 1. 3 attests, there are a lot of momentum traders. When they pounce on a stock, its average trading volume can easily double or triple in just a matter of months. This increased volume is the fuel that propels momentum stocks higher.

Ideally, one would use a momentum strategy because a price increase signals that there is good news about fundamentals that is not yet fully incorporated into prices. Sometimes, though, a price increase is not because of good news--but simply the result of more and more momentum traders climbing on the bandwagon, sending the stock's price higher and higher. And because momentum traders consider only a stock's price action when making their trading decisions, there is no way for them to know whether they are early or late in the cycle. Hence, they must accept the fact that sometimes they buy when earlier rounds of momentum trading have pushed prices past long-run equilibrium values--and not because of new information.

As a result, momentum traders have a tendency to push a stock's price grossly above its true value--which brings us to Newton's Third Law.

BEAR TRACKS

    III. For every action [stock that goes up], there is an equal and opposite reaction [stock comes down].

If only Newton's first two laws applied to momentum stocks, the strategy would be simple to implement and infinitely profitable. One would merely pick the best-performing stocks for a given period, and hold onto them as they continued into the stratosphere.

But, unfortunately, all traders have to live with the Third Law--that stocks that are traded way above their fair value have the tendency to fall from grace rapidly. Sometimes these issues drop because earnings are slightly lower than estimates. Other times, there is no explanation for why they drop.

As Figure 1. 3 shows, Qualcomm is no exception to the law of gravity. The stock dropped 35 percent in a seven-week period--for no fundamental reason.

Even with an IQ of 190, Sir Isaac had problems with the Third Law. "I can calculate the motions of the heavenly bodies," he wrote, "but not the madness of people." Neither Newton's intellect nor his scientific thinking could prevent him from losing £13,000 in the South Sea Bubble. The South Sea Company was formed in 1711 by a group of English merchants, who paid off the British national debt of £10 million in return for a 6 percent interest rate and exclusive trade rights with South America. Although the company never profited from its monopoly (and, indeed, failed to transact any business whatsoever), the prospects of such a scheme were so tempting that people fell over themselves to invest. By 1720, the expectation of immense profits drove the company's stock up 1, 000 percent in just a few months. The ensuing collapse of the stock's price nearly brought down the English government.

Often the first sign of an overheated market is the insistence of market participants to invest in stocks not because of their intrinsic value, but in fear of missing a potential rally. These types of investors are commonly known as the "weak hands" in the market, because their lack of conviction usually results in them fleeing their positions at the first sign of trouble. When that occurs, the sell-off in the market is sometimes large enough to affect other traders. This vicious circle can cause a protracted market drop. Nowhere is this phenomenon more apparent than in the world of momentum investing.

Market professionals use the term mean reversion when describing the tendency of stocks to reverse after a long run-up. What really occurs is not prices adjusting to new information, but rather investor expectations adjusting to the harsh reality that stocks simply cannot increase in perpetuity.

    Momentum Investing and Emerging Industries
    Emerging industries are often populated by large numbers of momentum players. Auto and radio stocks were immensely popular in the early 1900s, and witnessed huge price appreciation. But in the end, only a few selected market leaders from each industry were able to survive.

Consider the stock of Lucent Technologies (LU: NYSE), a bellwether of the technology and communications industries. Since it was spun off from AT& T, the company has had an enviable record of earnings growth and expanding market share. But LU's stunning announcement on January 6, 2000, that business had weakened during the previous quarter sent the stock reeling (Figure 1. 5).

As it turned out, earnings decreased by about 30 percent over quarter-ago levels. But the stock's price fell by a much greater amount--in other words, the market overreacted to the announcement.

Thus is the pattern for momentum stocks. News watchers readily buy into the stock as good fundamental information is released, but because they do not trade as a cohesive group, the price does not fully reflect all the information.

As the stock price increase is noticed by the momentum traders--a more uniform group, since they condition their buy patterns solely on the basis of price action--they tend to bid up the price of a stock quite aggressively. Eventually, the price is so far above fair value that even the tiniest bit of bad news can send the stock's price to the cellar (Figure 1. 6).

NEWTON'S LAWS: A HOLISTIC VIEW

In order to profitably exploit Newton's three laws in the trading of equities, one must consider that stocks often exhibit the following characteristics:

  • Stocks often trend in the short term. For those issues with low analyst coverage, earnings surprises and other firm-specific news are only gradually reflected in the stock's price. As a result, stock prices should drift upward in the presence of bullish news, allowing traders to establish profitable positions in high-performance stocks.
  • Stock prices mean revert over longer time horizons. Stocks that trend in the short run show a tendency for extreme price reversals over longer time periods. Indeed, stocks that have had the highest returns for any given five-year period tend to have low returns over the subsequent period.

"Wow," some readers might be exclaiming. "Is this all there is to it?" Armed with a powerful personal computer, a discount brokerage account, up-to-the-minute news, and Internet quotes, some readers might think it a relatively easy task to make money from these simple concepts. But a cursory examination of the behavior of individual traders might cast considerable light on this view.

A recent series of studies performed by Terrance Odean at the University of California sought to determine the profitability of the average retail trader with a discount brokerage account. The research examined over 10,000 brokerage accounts and nearly 200,000 transactions between 1987 and 1993, and revealed a number of broad psychological tendencies shared by many market participants.

These tendencies underscore the difficulty of generating market-beating returns. Traders might not be able to control market volatility, order entry problems, or the inability to get a decent number of shares of the hottest initial public offering--but they can definitely control themselves.

Problem I: Disregarding Transaction Costs

Individuals tend to buy and sell without regard to transaction costs. Profitable traders realize that one should buy a stock only if one's profit objective exceeds transaction costs. Generally, transaction costs are composed of commissions, which vary depending on your choice of brokerage firm, and the bid-ask spread, which ranges from a quarter to half a tick (i.e., 25 to 50 cents) per share. In Odean's study, the average cost for buying and selling a stock position was 5.9 percent. Unfortunately, the average trader was not willing to hold a stock until it appreciated that much, preferring to sell it as soon as its price registered a smaller gain. As a result, the accounts that traded the most were the least profitable.

Odean also found that women were consistently more profitable than men. It seems that the predilection of males to be trigger-happy also applies to the world of investing, as they consistently trade more often than their feminine counterparts. The higher commission bills generated by these extra transactions handicap men's accounts, allowing women to earn more profits.

Problem II: Buying Momentum Stock Too Late

Retail traders often like momentum stocks, but wait too long to buy them. Odean found that investors are indeed attracted to momentum stocks. However, they tend to wait until these stocks have run for a number of years before they are willing to initiate a position. By this time, the price of the stock is so far away from the fair value of the company that they sharply underperform the market at the first sign of trouble. According to Odean, it is likely that these investors are often the last ones to buy these stocks and among the first to suffer losses when the trend reverses to the downside.

Momentum investing is a viable strategy in the stock market. Many studies have documented momentum patterns in stock returns. However, these stocks establish reliable trends for only 12 months or so, and afterward tend to reverse.

The bottom line: If you are going to trade momentum stocks, remember that trends don't last forever!

Problem III: Selling Winning Positions

Traders may sell winning positions but hold losing positions. The transactions studied by Odean clearly showed that the average retail investor is quick at taking profits, and is especially fond of selling those stocks that have appreciated significantly in the two weeks following purchase. However, if a purchased stock goes down, the typical investor is more willing to keep it in the hope that its price will rebound. As a result, the average stock position maintained in an investor's account registers below-market returns, while the positions that were exited actually beat the market.

    Transaction Costs
    Watch out--there is a lot more to transaction costs than just commissions! In fact, commissions can be the smallest component. The biggest expense is generally the difference between the buy and the sell price, which is often called the bid-ask spread.

This puzzling result has an equally puzzling interpretation. According to the study, individual investors possess valuable information with which to trade. This information takes a number of forms, including recent price history, industry or company fundamentals, and order flow. However, instead of using this information to their advantage, retail investors misinterpret it to the extent that they consistently exit the stocks they should hold, and hold the stocks that they are better off dumping.

One of the oldest trading adages is "Let your profits ride, and cut your losses short." Why is this advice so hard to follow? Chalk it up to human nature. In all probability, we are probably wired to fail in the markets. The only way to succeed is to refuse to follow our instincts, which constantly bombard us with "A bird in the hand is worth two in the bush."

THE WORLDLYINVESTOR. COM MOMENTUM STOCK SCREEN

Having been confronted with the reasons why individuals are so often disappointed with their performances in the stock market, it is wise to consider the ways that such behavior can be avoided.

    Discretionary versus Quantitative Trading
    Many professional traders are discretionary--they make their buy and sell decisions based on experience and gut instinct. Quantitative traders, however, follow rigorously developed models in making their investment decisions. The screens in The WorldlyInvestor Guide to Beating the Market are all quantitative, and can be used by all investors, regardless of experience level.

The best way to avoid these issues is by utilizing a systematic approach to the markets, free of emotion and the human tendency we all have to tinker, second-guess, and delay our decision-making processes. And the best way to achieve these objectives is by using a stock screening methodology.

The core of the stock screening approach is in developing a quantitative method of choosing investments. Based on the general characteristics of momentum stocks described earlier, and the tendency for them rapidly to fall out of favor, a stock screen can easily be constructed to take all of these factors into account.

The worldlyinvestor. com momentum stock screen has the following criteria:

  • Small Cap Bias. To limit ourselves to those firms that have yet to be identified by a large number of Wall Street analysts, we will screen for companies that have a market capitalization below $3 billion.
  • Zacks Rank. We will focus on those stocks that have a Zacks rank (a proprietary measure of financial performance designed by Zacks Investment Research) in the top 25 percent of all listed stocks.
  • Short-Term Relative Strength. To ensure that our stocks have been noticed by other momentum traders, we will screen for those issues that have outperformed their peers in the most recent four-week period.
  • String of Earnings Surprises. Finally, our screen will focus on those stocks that have exceeded expectations in earnings growth.

The result of this screen is shown as Figure 1. 7.

A cursory glance at our potential momentum screen stocks shows that most of the selections are not well known. For our purpose, that is good--we aren't interested in buying what is known now, but rather what might become well known in the future!

FIGURE 1.7 The worldlyinvestor. com Momentum Stock Screen.

Further, our screen should result in stocks that have already begun to rise--like Point 7 on Figure 1. 3.

Let's examine a few of the more exceptional stocks on our list for those criteria we have described.

Comstock Resources (CRK, Figure 1. 8), an independent oil and gas producer, is a $219 million company with an impressive string of earnings surprises. The company has managed to exceed Wall Street expectations for the past six quarters. What makes the stock even more intriguing is its minimal analyst coverage. As of mid-2000, only seven Wall Street firms follow the company. If Comstock can continue its earnings growth, more analysts will inevitably follow the stock--which will drive institutional investor interest, and hopefully cause the stock to continue rising.

Shoppers may be more familiar with Sharper Image (SHRP, Figure 1. 9) than investors are. With $300 million in annual sales and a market capitalization of less than $200 million, the company may be too small for the radar screen of many mutual fund managers.

But if the company continues to impress Wall Street with its earnings growth--and its six consecutive positive earnings surprises--that may become a thing of the past. And with only six analysts monitoring the company's progress, there's still plenty of room on the upside.

1-800 Contacts Inc. (CTAC, Figure 1. 10) is a direct marketer of replacement contact lenses. The name of this company's game is volume, and it continues dramatically to increase its sales growth and profit margins through its proprietary management systems and well-known brand name.

Even though CTAC has experienced dramatic stock appreciation and rapidly growing earnings, only three Wall Street firms follow the stock. But the steadily increasing volume of CTAC shows that momentum traders have noticed its strong stock price performance.

Figure 1.11 shows the three most promising momentum stocks from our screen. To get a more updated list, please refer to the worldlyinvestor. com web site.

FIGURE 1.11 The worldlyinvestor. com Momentum Stock Focus List.

      WorldlyInvestor Quick Summary

    1. Momentum: What goes up keeps going up.
    2. What is behind the momentum in momentum stocks?
      • Low analyst coverage is critical. Returns in the one-third of momentum stocks with the lowest analyst coverage have been shown to be 60 percent greater than the returns for the one-third with the highest coverage.
      • "News watchers" initially process positive fundamental information on the company and cause the price to increase slowly. The dissemination of information is so slow that prices tend to underreact. Many companies at this stage regularly exceed quarterly earnings expectations with little change in their stock prices.
      • "Momentum traders" base their buy and sell decisions on past price action. They buy simply because the price is rising and have no interest in fundamentals. They initially act on the price increase caused by the news watchers and then on the feeding frenzy that they cause as their buying drives prices higher. Ultimately, prices overreact as more momentum traders enter the fray. Trading volume typically spikes as the number of momentum players dramatically increases the total number of market participants interested in the stock.
    3. What goes up must come down.
      • As a result of significant stock price appreciation, momentum stocks tend to suffer violent reactions to the downside once the stock has peaked. Often the slightest bit of bad news will have a dramatic effect.
    4. How to trade momentum stocks:
      • Look for stocks with low analyst coverage that appreciate slowly after bullish news.
      • Get in early. Momentum traders typically lose if they enter late due to the short-lived nature of the opportunity. Few momentum trends last longer than 12 months.
      • Go against the crowd and be willing to take your losses quickly, and let your profits ride. Take into account your transaction costs, and be sure that your profits will more than exceed your costs. Trade infrequently on higher-probability trades to keep your transaction costs low.
      • Use the WorldlyInvestor stock screen to identify potential high-performance momentum stocks.

Table of Contents

Introduction: The Individual Investor of the Next Millennium.

STRATEGIES FOR INDIVIDUAL STOCKS.

Momentum Stocks for the Short Run.

A New Paradigm for Growth Stocks.

Uncovering the Value in Value Stocks.

Distressed Stocks, the Dregs of the Market.

INDEX TRADING WITH EXCHANGE-TRADED FUNDS AND MUTUAL FUNDS.

Exchange-Traded Funds—The Next Generation of Indexed Investing.

Trading ETFs with Publicly Available Informaton.

Exploiting Calendar Effects with Exchange-Traded Funds.

The Strategy Your Mutual Fund Manager Doesn't Want You to Know About.

TOPICS FOR ONLINE INVESTORS.

Using the Internet to Beat the S&P 500 Index.

Three Rules for Investment Success.

The WorldlyInvestor Guide to Selecting Mutual Funds.

Market Timing Strategies with Mutual Funds and Exchange-Traded Funds.

Bibliography.

Additional Recommended Reading.

Glossary.

Index.

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