Rev Shark:
Momentum and Its Discontents
5/20/05 8:15 AM ET
Momentum is for idiots and jokers.
-- Jim Cramer, Mad Money, Wednesday, May 18, 2005
Momentum is one of those stock market concepts that is extremely easy to criticize because it so susceptible to misuse. Unfortunately, many folks use the concept of momentum to justify their bias against selling stocks and taking profits. Many of these folks were destroyed in the bubble days when they refused to recognize that upside momentum had ended and was not going to return quickly.
But the concept of momentum is essential to making money in the stock market. As that joker known as Sir Isaac Newton recognized, objects in motion tend to stay in motion in the same direction unless acted upon by an outside force. The same is true in the stock market. Once a trend begins, it tends to continue for some period of time, and that is what makes it possible to make money in the stock market.
What is the alternative to momentum trading? Endless buying a stock that is downtrending? You won't make any money that way unless the stock eventually reverses and gains some upside momentum.
Momentum is nothing more than the recognition that to make money in the market, buyers have to eventually come to the realization that a stock is worth buying, and drive the price up. If the stocks you buy never gain momentum, you will never make any decent money.
Jim Cramer's comment above is probably his subtle way of conveying the idea that you need to take profits now and then. Momentum is a very dangerous thing when you fail to acknowledge that it won't last forever and that when it ends, it tends to end rather quickly and without much warning.
If you have had a good run in recent weeks, it probably is not a bad idea to take some profits and/or tighten stops. It is effective money management that determines who the jokers and idiots are, not momentum.
The big question we face as we wrap up the best week of the year so far for the indices is whether the rally can continue. One of the things about momentum that makes it such a hard concept to handle is that it tends to last longer than is reasonable. By almost any measure, this market is extended or overbought or whatever you want to call it. We made a big move and need a rest, but there are still lots of folks who want in, and bears who are covering, and they keep these moves going.
Keep in mind that momentum does not die easy. In fact, a pause or a pullback when merely strengthen it. The big mistake is to assume that the market will suddenly roll over and go straight down after the big recent move. Momentum tends to be a rather stubborn thing, because it stirs up strong emotions.
So yes, we probably are due for a rest, but keep in mind that momentum is positive and the trend is up.
We have a slightly weak start shaping up this morning. Oil is inching up, and after a big week, some profit-taking is due. Keep on eye on those dip-buyers -- they are our best evidence of the degree of buying interest.
Thanks to Cody for doing another fine job in my absence. I appreciate it.