Momentum Trading: It's OK to Be a Slave to Time

Editor's Note: With this column we introduce Ken Wolff, who will write regularly for TSC about momentum trading, also known as daytrading. Wolff is founder and chief executive officer of Mtrader.com in Paradise, Calif.

---

So what if I have four alarm clocks that go off at 4:30 every morning? And so what if I've assigned a specific lunch menu for each day of the week? Do you think I am a little obsessive-compulsive? Well, maybe I am, but that's one reason I was born to be a daytrader.

To daytrade, you must be compulsive, not necessarily about food, but definitely about time. I'm a slave to time. I've trained my internal body clock to revolve around the daily cycles of the market. For example, I never go to the bathroom during the first two opening hours -- I've learned to forgo that cup of morning java.

Stocks not only react to momentum and news but they also react to the time of day. If you look at my daily trading-cycle time chart, you will see, as it is with all things in life, the beginning and the end are the most important -- and it's not all excitement all of the time. There are definitely periods that are "target rich," but also periods to avoid trading altogether, like the sucker-rally hour. That's when I stop trading and switch the television set from CNBC to Comedy Central.

Trader's Timeline The sweet spots are at the beginning and end of the day.

Generally speaking, a stock makes its largest movements within the first two hours, between 6:30 a.m. and 8:30 a.m. PST. Between these two hours, the first half-hour is when I see the most action unless a news story breaks later in the day. These are the target-rich periods and the time I make my highest-percentage trades.

Take a look at the chart on ViroPharma (VPHM Quote). On Jan. 18, rumors that the small biotech company had a cure for the common cold created quite a bit of momentum for the next few days. By Jan. 21, with this news and the fact that biotechs were strong, ViroPharma traded at more than three times the average 30-day volume. It opened up at 67 7/8 and swung widely in the first two hours then settled down into a narrow trading range for the remainder of the day. This early period is when I always ride the momentum and oscillations because the potential built into the stock is the greatest.

I'm normally done with most of my trading by 9 a.m. PST, and spend the rest of the day looking for news that creates momentum. Trying to play later-day rallies tends to lower winning percentages because they often weaken very fast. After 8:30 a.m. PST, stocks will form a small trading range and oscillations narrow, leaving considerably less potential for me to play. This is the time to eat lunch. (Monday's lunch is always turkey on rye.)

Between 11 a.m. and noon PST there is a general weakness in the market. I see many false rallies during these periods. They usually go up one or maybe two trading ranges, then fall just as fast to the bottom of the oscillation. I always skip these rallies and finish lunch with my lovely wife, Helen. (Tuesday's lunch is egg salad on wheat.)

Before I became the old, experienced daytrader I am, I used to be addicted to the rush of the trade and traded many times a day, all day. But I've learned the value of a good sandwich (Wednesday's lunch is tuna on white), and that trading during lunch is a waste of time. It's not worth trying to force something out of the market; it only increases risk and losses over the long run.

After a tasty lunch, sometimes I glance down the hall at the bedroom and fantasize, albeit briefly, about a nap. Who needs to be tempted by those sucker rallies anyway? But no, I can't. The action usually picks up between noon and 1 p.m. PST. That's when I look for late-breaking news or oscillations of three-fourths to 1 point or more. If I skipped out after lunch, not only would I have missed these swings, but also the end-of-day "gappers."

The gappers are what make the end of the trading day exhilarating. These are the stocks I buy, literally, in the last few minutes before the closing bell. I look for the news or the momentum that causes these stocks to gap up higher than they closed the previous day. I don't normally hold positions overnight, but when these patterns are active they can produce phenomenal gains. However, they can also expose even the most savvy daytrader to increased risk. Oh the thrill of it all!

Sybase (SYBS Quote) is an example of a good gapper play. Shares rose 23% on Jan. 20 after this database-software maker reported better-than-expected fourth-quarter financial results. In the last few minutes of trading the momentum picked up, creating an excellent overnight gapper on the next day.

So I've come to appreciate the obsessive-compulsive part of my personality as an asset to my trading. I may be wound tighter than my grandfather's watch, but I know what moments of the day produce the highest-percentage trades and I enjoy them all. (And if you're dying to know, Thursday's lunch is chicken salad, and Friday's always vegetarian pizza.)