Why You Don’t Buy High Momentum Names and Breakouts In A Choppy Market
- Posted by Leigh Drogen
- on July 2nd, 2012
Listen up because this is an important lesson. Breakouts do not work in choppy markets, and the odds of a disaster taking place in your momentum stocks rise precipitously. This is a fact, don’t fight it, argue with it, reason with it, avoid it, just honor it. You do not want to be highly exposed to high growth, high momentum stocks in choppy or bad markets, no if, ands, or buts.
Every day on the stream I see people trying to reason with me about why their individual stock is setting up for a breakout, looks good, is strong, on and on. Look, yes, your stock does look good, you’re right that pattern is healthy, yes it is a new market leader. What you’re missing kimosabe is that the majority of how any stock moves is due to the market as a whole. Simply put, you do not want to be buying breakouts, high momentum, or high growth in a choppy market, because the odds are that the market is going to fuck it up, no matter how good it looks.
Will the market always fuck it up, no. But this game is not about finding the outliers, this game is about playing the odds. When the market is strong you want to pile into the leading stocks on margin, and when the market is choppy you want to avoid these things like the plague because after the market has had a great run, like it did last winter and spring, those stocks that led often get taken to the house when the music stops, and it certainly has stopped, for now. Most of them won’t just bide time, no, they get decimated. Look around you at former market leaders LULU, NKE, MCD, RAX…. all crushed.
A smaller former leader like LQDT is down another 25% today. Yes, these stocks have individual issues, but that’s not the point. When the market takes a break, or has broader issues like it does right now, and we see a return of volatility like we have, these issues all get magnified. Slight earnings beats of the sell side consensus get seen as “not enough” by the buy side. Decent guidance numbers that in a good market everyone would have said were sandbagged become “disappointing guidance warnings” from the company. In short, shit is seen as half empty instead of half full. That’s just what happens.
I know you want to buy those leaders that haven’t broken down, like WFM or ALLT….don’t. Odds are that the choppy market is going to hold them back, and you never know when you’re gonna wake up and see them down 10%. The odds are just not in your favor right now. Don’t be afraid to miss the first few percent of the rally, because if it’s real, most of the gains in the individual names won’t take place until the end of the rally, that’s how this works. You have plenty of time to get involved, but if you’re trading in and out of these things all summer while breakouts fail and momentum stocks get crushed, you’re going to lose a bunch of dough.
And more importantly, if you get chopped up enough during the summer months, when the market really does get healthy, you won’t be in the right state of mind to really pile in like you should. You’ll hold back and play it safe, you won’t double down on those 10’s like you should and make your money when the odds are in your favor.
This game is all about putting the most chips on the table when the odds are right. Understanding the broader market is what allows you to know when that time is, and yes looking at individual stocks is always important to understand who the leaders are, but the most important thing to know is when the broader market is giving you a red or yellow light.
Don’t force it.
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Leigh Drogen is the founder and chief investment officer of Surfview Capital, LLC, a New York based investment management firm employing an intermediate term long/short momentum strategy. More »
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