2021 continues to be a superb year for U.S. stocks, while the same cannot be said for China.
S&P 500 has gone up 19% since the start of 2021 up to the time of this writing.
The market trend has been great for momentum trading.
For those who are not familiar with momentum trading, you can think of it as the polar opposite of value investing. In value investing, you buy low and sell high, while in momentum trading, you keep in mind that low can go lower. Momentum involves trading in the direction of the trend, and that means buying high and selling higher.
Both types of trading works but in different timeframes. In value investing, the price can take time to rebound, often it takes years, but the rewards are huge. On the other hand, momentum trading usually takes a shorter time to rebound, but the trend would likely die off after a few months. Hence, value and momentum don’t contradict each other because their timeframes are different.
To give you a better idea, I will share five S&P 500 stocks that currently have the highest momentum.
#1 Moderna (MRNA)
This company needs no introduction, as some of you might have taken a Moderna vaccine shot to combat Covid-19 (or it is memorable for you because our minister mispronounced it as “banana” in Parliament).
They consider their company as an “information medicine-based platform.” mRNA is a set of instructions for our human cells to make proteins, hence it is information-medicine. It is a platform because the discoveries are modular and can be applied to other therapeutic areas, such as oncology and autoimmune diseases.
Basically, it is new medicine grounded in biotechnology.
I sucked at biology as a student so I’m not the best person to explain how all these work.
But in momentum trading, I don’t need to know the business in-depth in order to trade.
I just need to rank the entire S&P 500 component stocks by their momentum values, and when I did so, Moderna came out on top with an Exponential Regression score of 2,515.
The first entry was on 30 Jun 2021 and it had gained 92% as of 13 Sep 2021. At present, its momentum value is still going up.
#2 Monolithic Power Systems (MPWR)
Monolithic Power Systems comes in second place, with an Exponential Regression score of 320.
The company focuses on making tiny electronics to power a myriad of devices and machines used in cars, servers, consumer products, and more. Their future looks bright with the emergence of the Internet of Things (IoT). Below are some examples of the parts they supply.
MPWR’s revenue growth rate has been consistent and stable for the last 20 years – you can see its exponential rise on the chart below!
The buy signal recently happened on 30 Aug 2021. You can see that the share price has already gone up quite significantly before the buy signal came in. Momentum trading works in such a way that you don’t buy at the bottom or sell at the top, you take profits in the middle.
The share price now is lower by 3% compared to the first buy signal.
#3 Dexcom (DXCM)
Dexcom has an easy-to-understand business – it provides a glucose monitoring system for people with diabetes.
Diabetes is a chronic disease, which gives Dexcom a recurring business for existing clients. Its core markets are in North America, Western Europe, Australia, New Zealand, South Korea, and Japan. Aside from its current clients, there are 10 million more people who need their monitoring system, according to Dexcom.
Dexcom ranked third in terms of momentum, with an Exponential Regression value of 317.
The buy signal started on 27 Aug 2021 and has gained 3.5% after only 10 trading days.
#4 Fortinet (FTNT)
Fortinet is a renowned cybersecurity company and has the second-largest revenue in the industry, after Palo Alto Networks.
It offers both hardware products (30% of revenue) and software services (70% of revenue). To keep up with the times, Fortinet has moved its services to the cloud and provides a holistic suite of cybersecurity solutions.
Fortinet ranked 4th in terms of momentum, with an Exponential Regression of 299.
The buy signal started on 25 Feb 2021 and the share price has gained 77% since, which is better than the S&P 500. How long will it continue to grow? As long as the trend keeps going up and there’s no sell signal, keep holding!
#5 Paycom Software (PAYC)
Paycom is an HR software provider that boomed recently as tracking remote staff is now a necessity for companies and will continue to be essential post-Covid.
Below is an overview of its HR software solution:
When it comes to fundamentals, I don’t think PAYC has a strong and wide moat because HR is just one of the many components of a company. Providing an Enterprise Resource Planning (ERP) software would have been more holistic and integrated. Unless Paycom has some killer features that will keep its users happy, I don’t think its business is a good long-term investment.
But momentum trading with Paycom is still a good strategy.
The buy signal first appeared on 2 Sep 2021 and now the price is 7% lower. You might be wondering why enter at a one-year high instead of waiting for a price drop? Well, you never know whether it will decline or not, and sometimes the price can just rebound without you.
I know it can be counterintuitive to buy based on momentum; however, it has a history of strong returns even if it means buying on highs. If you try just a small sample of these top five stocks, the gains from MRNA (+92%) and FTNT (+77%) are more than enough to cover small losses. You can’t be right all the time, but you can make sure your gains are much larger.
Momentum trading maxims
It’s important to note that momentum trading requires sufficient diversification since you don’t know which stock’s momentum is going to last longer than the rest. You don’t want to buy one or two stocks – only to see both their momentum collapse.
When I was just starting out, I did momentum trading but found it tedious because I had to look at individual charts and then visually identify trends. Now I can quantify the trend and do rankings easily. I don’t need to look at the charts to trade. But I included them in this article so that it would be visually easy to see for you. It saves lots of time!
Although I’ve shown that you can apply momentum to index components, the better way is to combine momentum trading with other fundamentals, such as value or quality, to improve returns.
It is best to apply momentum on the long side and avoid the short side. There is a phenomenon known as ‘momentum crash’, where you short side stocks and they rebound strongly after a market crash – this can wipe out your entire account.
Nonetheless, momentum trading has been one of the longest and most popular strategies used by professional traders for the past 70 years.
Come for my free webinar and I will share more about momentum trading and how you can add a quality factor so that you can combine both fundamentals and technicals in your approach.
Disclaimer and disclosure: I am not a financial advisor and I am vested in Fortinet.