Technical Thoughts: Momentum Trading Or Dip Buying?

Written by Jeff Miller, A Dash of Insight

— This post authored by Mark Hines

Are Momentum Trades Better Than Dip Buying?

The answer to that question depends, of course, on a variety of factors including your trading personality, your timeframe, how you manage risk, and market conditions, to name a few. Our models (as shown in the following table) have been developed to take advantage of opportunities depending on all of the above factors. And we’re having continued success, but more data and evidence is never disparaged. After all, trading style can work well; until they don’t.

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As the above table shows, some of our trading models utilize momentum strategies (Felix, Oscar and Athena) while others use some form of dip buying (Holmes and RoadRunner). For some perspective on how momentum stocks have been performing recently, here is a look at the iShares momentum index (MTUM) versus the S&P 500 (SPY), year-to-date.

As the chart shows, the momentum trade is basically lapping the strong performance of the S&P 500 this year. And regarding our models, momentum strategies (Felix, Oscar and Athena) have been outperforming dip buying models (Holmes and RoadRunner), which is not surprising considering the strong performance of MTUM. However, our dip buying models have been holding their own. And when the models are combined, they’ve been outperforming the market, with a low correlation to the market (a very attractive quality). However, as mentioned previously, more data and evidence is needed.

When implementing our models, we generally allow them to do their thing with limited human interaction – after all, we designed them to avoid many of the common mistakes that human traders often make, such as complacency, data overload, fear, unrealistic expectations, disciplined entry and exit points, and position sizing, to name a few.

And with regards to models working well – until they don’t; one of the biggest factors that could cause a shift from momentum and possibly to dip buying is a business cycle peak. Alternatively, one of the biggest upside chances from the market could come from a market-friendly policy environment, which could provide a healthy foundation for stocks with plenty of upside. In fact, we covered these topics (and more) in our recent webinar presentation: The Most Important Year-End Questions for Investors. You may have to take a moment to “sign up” before accessing the webinar, however we believe there is a lot of good information worth reviewing.

(webinar link)

Without further ado, here are this week’s model picks…

Expert Picks from the Models

This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger (also known as Mark D. Hines). Blue Harbinger is a source for independent investment ideas focused on value and income opportunities.

Holmes: This week I bought Vipshop Holdings (VIPS). Are you familiar with this company?

Blue Harbinger: Yes. It’s a Chinese company and it’s an ADR. It’s basically an online discount retailer for brand names. They have flash sales where they have a limited amount of brand name products to sell.

Holmes: Well the stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see it is below its 50-day and 200-day moving averages. And it has attractive upside over the next six weeks.

BH: This company’s revenue has been growing rapidly in recent years. From the FastGraph below you can also see the earnings per share has been growing too, so that is a good sign. Do you know what this company’s total addressable market is?

Holmes: Total addressable market is difficult to quantify. However, my typical holding period is about 6-weeks, so I’ll be in and out of this one long-before total addressable market becomes an issue. Besides, China is big.

BH: Remind us Holmes, what exactly is your style?

Holmes: My style is based on dip buying and mean reversion. I’m really into protecting assets too. My process drastically reduces vulnerability to drawdowns while attempting to stay invested for the longest possible period of time. I use a mix of advanced trading techniques (including profit taking, stops, and trailing stops) and technical analysis to help protect if the stock price starts to fall from.

BH: Well listen, Holmes. This stock has pulled back significantly since the summer (the dip-buying opportunity you’re talking about), and it’s not just random noise. Vipshop just had a disappointing earnings announcement last quarter. Plus there is a lot of competition in the Chinese online marketplace.

Holmes: There may be a lot of online competition in China, but as you already mentioned, Vipshop’s revenues and EPS continue to grow. Talk to me in about six weeks, and we’ll see how this pick has done.

BH: Deal. How about you, RoadRunner. What have you got this week?

RoadRunner: I like Hertz (HTZ) this week. As you know, I like to buy stocks that are at the bottom of a rising channel, and if you look at the chart below you can see why I like Hertz this week.

BH: Interesting pick, RoadRunner. If you recall, Athena picked this stock back in early August, and considering she typically holds for about one month, it looks like she nailed it.

RR: I’m happy for Athena, but she could have let this winner run for about four more weeks – that’s my typical holding period.

BH: RoadRunner, Hertz looks like a disaster to me. Not only is the price down, but the earnings are way down (they’re actually negative), the short-interest remains extremely high (around 31.2%), and I just don’t see how they’re going to turn things around anytime soon considering the company is working so hard to reduce its car rental fleet size (i.e. they’ve got more cars than customers). I suppose you could say Hertz has been “Ubered” or perhaps “Lyfted” considering those ride sharing services have really decreased the demand for car rentals. For your reference, here is a look at the FastGraph from Chuck Carnevale. Chuck’s tools are the best, however that appears NOT to be the case for Hertz.

RR: You’re not thinking like a trader, Blue Harbinger. My holding period is typically about four weeks, not four years. I’ve been having a lot of success buying stocks in the lower end of a rising channel. It’s a mean reversion trade within a broader momentum theme.

BH: Interesting, RoadRunner, did you also know that Felix picked Hertz back in late June, but considering he usually holds for about 66 weeks, the jury is still out on his trade.

Felix: Hertz is still interesting, and we could actually see one heckuva short squeeze at some point. Especially, if those ride sharing services you were talking about start facilitating significant purchases from Hertz’s fleet for their drivers. However, this week I have something else for you.

BH: Oh yeah, what’s that?

Felix: This week, I’ve run all 30 of the Dow Jones stocks through my model, and you can see how they ranked below:

BH: That is interesting, Felix. Based on your ranking, it’s pretty clear you are in fact a momentum trader. You’ve ranked many of the best performing Dow Jones stocks at the top your list, and many of the worst at the bottom. For your reference, here is the recent performance for all 30 Dow Jones stocks.

Felix: My strategy is based on momentum. As you already mentioned, I typically hold things for about 66 weeks. I exit when my price target is achieved, and I use macro factors and stops to control risks.

BH: Well, I suppose you and I are more similar than some of the other models because your average holding period is over 1-year. That is sort of long-term, I guess. However, we disagree on methodologies. For example, you have Caterpillar ranked near the top of your list, and I actually just recently sold my Caterpillar shares for a big profit after holding them for about 19 months.

Felix: You need to learn to let your winners run, Blue Harbinger. How about you, Athena. Do you have anything this week?

Athena: I don’t have any specific stock picks this week because I don’t like to force anything when the opportunities are not right. However, since you ran the 30 Dow Jones stocks through your model, Felix, I did the same. Here you go.

BH: Interesting, Athena. I can see you too are a momentum trader considering you’ve ranked Boeing (the best performing Dow stock this year) at the top of your list and General Electric (the worst performing Dow stock this year) at the bottom of your list.

Athena: There is a lot more to the rankings than simply performance. Plus, my trading process uses price targets, I only hold positions for about one-month, and I manage risks with stop orders. And I have a growing track record of success.

BH: Regarding your bottom ranked stock, General Electric (GE), we could see some fireworks from them over the coming few weeks considering all the expedited leadership changes lately, earnings announcement today, and big investor presentation from the new CEO John Flannery scheduled for November 13th. I actually wrote about this company just this week: GE: How to Play the Dividend Cut Fear.

Athena: I’ve heard about all the things you mentioned, but they’re not my biggest concern considering there are plenty of Dow Jones (and non Dow Jones) stocks I like more than GE.

Conclusion

With regards to momentum and dip buying, one is not necessarily better than the other, but there are times (market conditions) when one works better than the other. Depending on individual investor needs, we find that using a mix of both trading styles can improve results by delivering strong, often market beating returns, with significantly low correlation to the broader market. We don’t apply our strategies by buying all the stocks in a specific universe like an index or and ETF would. Rather, we use our models to select attractive individual stocks, and we continue to have growing success.

Background on the Stock Exchange

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out http://dashofinsight.com/background-stock-exchange/ for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!