Is Now The Time For Momentum Stocks?

By Casey Murphy | July 11, 2014 AAA

In active trading, there are various avenues to take when picking stocks. In some cases, traders will take positions in stocks that are trading within strong trends in anticipation that the crowd will be caught on the wrong side and that the price will drastically swing in their direction. This type of trader is known as a contrarian. Deciding when the trend will reverse is the hard part of such a strategy, and some traders will invariably find themselves holding onto a losing position while the momentum continues.

As of late, traders waiting for a reversal have only seen stocks climb higher, which is why there has been a rise in popularity in a style known as momentum trading. The theory used by momentum traders is that the ‘trend is your friend until it ends.’ Momentum traders will stick with their position in a defined trend until they receive confirmation from several technical indicators that suggests the trend is reversing.

For those who don’t closely follow the market, choosing a momentum stock can also be difficult because at this point in the trend many technical and fundamental indicators suggest that the stock is fully valued and ripe for a pullback. Rather than choosing a momentum stock blindly and adding it to a portfolio, it may prove wise to check out the iShares MSCI USA Momentum Factor ETF (MTUM). As you can see from the chart below, this ETF is been trading within a strong uptrend ever since its inception on April 16, 2013, and it doesn’t look like it is about to reverse any time soon. (For more, check out: Introduction To Momentum Trading.)

Looking at the Components of MTUM

The iShares MSCI USA Momentum Factor ETF tracks large- and mid-cap U.S. stocks that exhibit strong price momentum. The fund currently has $307.7 million in net assets and holds 125 different stocks. The ETF is relatively liquid and carries a reasonable expense ratio of 0.15%. In terms of sector weighting, the MTUM ETF is heavily weighted toward health care, industrials and Information technology, which as suggested in previous articles, are all trading within extremely strong uptrends. Top holdings of the MTUM fund shown in the table below could be great candidates for any active trader's watch list. (For related reading, see: This ETF Will Deliver Upside With Downside Protection.)

Holding

Weight (%)

Sector

Wells Fargo & Co. (WFC)

5.08

Financials

Facebook Inc. (FB)

5.01

Information Technology

Merck & Co Inc. (MRK)

4.96

Health care

Johnson & Johnson (JNJ)

4.95

Health care

Union Pacific Corp. (UNP)

2.62

Industrials

Trading the Momentum of Facebook

Facebook has been a momentum stock of choice for many traders since August 2013 when the company announced better-than-expected earnings. It showed the market that it was figuring out how to monetize mobile traffic at a faster rate than expected. As you can see from the chart below, the golden crossover between the 50-day and 200-day moving averages back in August 2013 was the signal of the beginning of a long-term uptrend. Many active traders will likely hold a position in FB until it closes below the support of its 200-day moving average. The recent tightening between the peak near $72.50 and its 200-day moving averages provides momentum traders with a more favorable risk/reward ratio and could lead to heavy buying over the weeks ahead.

The Bottom Line

When it comes to active trading, strong trends can last much longer than expected. This has led to a rapid increase in the popularity of exchange traded funds such as the iShares MSCI USA Momentum Factor ETF, which have been designed specifically to track this trading style. For traders looking for momentum candidates for their own portfolios, it could be a great idea to check out the components of the fund listed in the table above. For further reading, see: Momentum Trading with Discipline.

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