How Momentum Beats Market Timing in Trading

11/17/2020 10:00 am EST


Bob Lang

President and Chief Options Strategist, Explosive Options

There are two schools of thought when it comes to technical analysis: Follow the trend and momentum, or base decisions on timing signals, states Bob Lang of Explosive Options.

When we look at each methodology in isolation it is clear the momentum crowd has the edge. Timing bets are difficult to establish, as we often say, “searching for tops/bottoms is a sucker's bet.”

My good friend and mentor, Dave Landry, is a self-proclaimed “trend following moron.” Dave recognized long ago the power of the trend and following momentum can lead you to substantial wins and eventually riches. I learned the secret of trend following many years back, and it has served me well over the years.

Now, of course timing can be a fruitful exercise, but is more likely an investment tool rather than a trading tool. The mechanisms for successful timing bets include sentiment indicators, overbought/oversold readings, and reaction to news stories. One can build a nice portfolio timing the market after a crash has occurred.

This past spring saw the biggest short-term decline ever for a month, the SPX 500 (SPY) falling by 34% in that short time span. Trying to time a trade was nearly impossible with the extreme volatility, yet some of the ridiculously low prices became some of the best buys in nearly 12 years.

The financial crisis of 2008/09 was the last opportunity to snap up stocks that were sent to the woodshed. Names like Bank of America and Amazon flirted with disastrous consequences but have been flying high ever since. If you traded the stocks, you likely did not hold and sit with regret. Good timing.

Momentum is a completely different style. This involves finding strong trends in the present, identifying direction, and going with the flow of money. Whether up or down, it really doesn't matter. The market is all about liquidity, and the money flows dictate price action. When it's strong and prices rise, they tend to continue moving higher. Some of the better momentum names in 2020 include Peloton (PTON) and Zoom Video (ZM).

We know how well these names have performed, and most just watch from the sidelines as they move from lower left to upper right on the chart. These stocks and many others show their power regardless the condition of the current market. When buyers want in, they get in, and ride the trend.

Choose your style. For trading, it is momentum, and for investing include some timing bets at the extremes (highs or lows).

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