Momentum Stocks

For those of you that might have taken a physics course, you probably know Newton’s Laws of Motion. The first law says “an object in motion continues in motion with the same speed and in the same direction unless acted upon by an unbalanced force”.

Stock traders apply this principle by buying only stocks that are on an uptrend. The rationale is that they are likely to continue trading in that direction unless an outside news, event or a revelation that the stock price is overvalued causes it to stop doing so.

Because the PSE index is in a clear up trend, there are many stocks that show this pattern. Some are more definitive than others, but the ones I like with the graphs show below are URC and EEI:

universal robina corporation news

eei corporation stocks

As you could imagine, investing in momentum stocks is risky. Contrary to the approach of buy low and sell high, the approach is to buy high and sell higher. The timing on when you sell is important, so you have to vigilant.

How do you know when to sell because an outside force has forced the stock out of its trajectory? When the uptrend is broken-you sell.  Of course you can vigilantly follow the company for that news or event. Better yet just follow the price action, it is difficult to former.  If the uptrend is broken, then that outside force must be in play.

How do you prepare for that? What traders do is enter a stop loss order.  With a stop loss order, you establish a percentage of down movement that would trigger your broker to sell the stock. For example if a stock is at 20 and you want to sell your position when it goes down by 10%, you then order your broker to sell the stock when it hits 18 or lower. Basically, you have established a 10% down move to be a signal that the outside force referred to earlier is now in play.

The problem with a stop loss order however is it does not protect the profit that you have accumulated if the stock continues to go up. After all the 10% threshold should be applied to the highest price reached, not at any stock price. The solution to that however is to use a trailing stop loss order.

With a trailing stop loss the 10% is applied not at the current price or the price you have established, but at the highest price reached by the stock. You do not have to monitor when the highest stock price reached is reached. The broker has a system to do it for you.

After having said all this, I am not sure all brokers in the Philippines can execute for you a trailing stop loss order. If your broker cannot, you have to diligently watch the stock yourself and place the order manually when there is an appropriate signal.

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