bottomed a little before 1 p.m. EDT last Wednesday, I stuck my neck out and started buying longer momentum plays. This bottom was different from the previous bottoms and was fairly easy to identify, if you're familiar with using the "indicator" technique I discussed in my April 10 column,
Don't Buy Until You See Blood in the Streets. Although the rules have changed a bit due to current market conditions, and I played it slightly differently, the indicator method worked like a charm. Let me tell you how I played it to give you a better understanding of the market dynamics involved.
The nervous market conditions in the past several weeks had forced me to go back to my roots in momentum trading, concentrating on smaller priced stocks and smaller gains. With the increased volume and momentum on Wednesday, it forced me to change tactics again, back to using my indicator method and playing the larger momentum stocks again.
For those of you who don't remember, the indicator stock is a stock that I pick prior to the open, which I expect to lead the market, bottoming and topping out prior to the other leading stocks in that sector. This allows me to watch the indicator stock, look for a bottom or top then play the
The indicator stock I picked on Wednesday was
. Everybody was watching it and talking about it on
and among momentum players, calling 50 as the critical resistance level. It is also a top institutional holding in the tech sector.
On Monday and Tuesday, the market opened with buying, but was met with massive selling. Each rally was a war between the buyers and sellers, with sellers winning the battle. The premarket gaps (between the previous day's close and the current open) were weak at best, disappearing before the market opened -- indicative of a weak market.
On Wednesday, the gaps faded again and my indicator stock made several quick bottoms (points a, b) before 2 p.m., each bouncing off the 50-point resistance level. At these bottoms, the buying was not very strong and was mixed with selling, indicating a weak bounce. In addition, the tops were very quick, keeping me out of most plays early on except for a few quick momentum plays.
When Cisco bottomed at around 1 p.m. (point c), it was clearly different from the previous bottoms. The volume and pace were considerably greater, with many big block trades telling me that institutions were jumping in. Pace in the market is important in spotting momentum. I like to look at 60 stocks at once that represent sectors such as Internet, software, computer, chip makers, etc., on a Level I screen, and watch the trades per second on average.
I use a RealTick III quote software program that shades each stock as it gets a buy or sell. The shading makes a blinking image that reflects the action in those 60 stocks, and when I see the shading begin to blink faster I know that there is some action in the market. That is very important to spot the market highs and lows each day because market tops or bottoms are preceded most of the time by a slowing of the trading pace.
When I see stocks at the bottom, paused from downticking, and the blinking action (pace) begins to quicken, I will go long, and exit, when the blinking action slows again. It's a very effective way of finding the market bottoms and tops. I do the same when shorting a weak market each day, when the leaders in the day's buying pause at the highs and the pace slows. Simple technique, but it works great.
Normally, I wait until the indicator stock climbs a full two points to ensure the momentum carries through prior to jumping in and buying the follower stocks. However, when Cisco bottomed, the volume and pace were extremely high and fast. This, in addition to the big block trades, marked this as clearly different from the previous market bottoms. At this point, I stuck my neck out and called bottom, and promptly went on a buying spree. I bought anything that was following the indicator stock, but concentrating on leader stocks such as
Note that there was not much of a delay between climb of the indicator stock (Cisco) and the follower stocks. The safe way to play this was to wait until Cisco climbed up two points from the bottom to ensure the momentum was going to carry through, but the pace, volume and big block trades made me jump in. There was no magic formula used here: I simply bought the leader stocks that showed upward momentum, and were following the indicator stock. All could have been sold near the market close, capturing short-term profits, or held until the next day watching for a carry-through of the upward momentum.
The indicator method is simply the best method to identify short-term bottoms and tops. When the volume and pace is high, it is a thing of beauty to watch. If you are trading simple momentum without using methods such as the indicator, you can see how traders can be lured into sucker rallies and get stopped out frequently. By the time the real bottom is made, you are so badly shaken up, you miss the real and profitable move up.
Questions concerning my indicator method are the most common emails I get, and for good reason: It works. You cannot appreciate how well, unless you see it in action, real-time, but I would like to offer you the next best thing. If you email me, I will send you Mtrader's full, unedited log from last Wednesday. I recommend you take the time to review the log, while looking at the charts to get a full appreciation of the method.
You will see from the logs, I stuck my neck out and called the bottom on the Nasdaq on Wednesday. This may or may not be the long-term bottom. Only time will tell. But it certainly was a short-term bottom and representative of how experienced traders can find and play momentum in even the most turbulent markets.
Ken Wolff is founder and chief executive officer of Paradise, Calif.-based MTrader.com, a daytrading and swingtrading Web site. This column provides general information about momentum trading. TheStreet.com has no affiliation with MTrader.com, and no endorsement of MTrader.com or momentum trading is intended. While Wolff cannot provide investment advice or recommendations here, he invites your feedback at