For the last few months I've been trying to give you a peek behind the scenes into the causes of the hidden momentum behind the market. This is what separates the amateurs from the professional traders. If you understand what forces are acting on the market and the players making it move, you will possess a keen insight on what to expect from individual stocks.
With the recent dramatic drop in the
Nasdaq Composite Index
Dow Jones Industrial Average
, the primary players have changed, which changes the way I play individual stocks. Welcome to the new show.
The market has shaken out many online traders. I say this because I haven't seen a lot of gapping action, which is when stocks open noticeably higher or lower than their previous day's close. The gapping action is primarily caused by daytraders and the online investors who come home from work, read the news and place overnight orders. They are a hurt bunch of investors who have seen what the market can do to the darlings of yesterday's rallies. They are gun shy, and for good reason. Many online traders and investors have been whacked hard and have seen a
percentage of their gains swept away in just a few short weeks.
The online trader is not back yet and we must follow the leader in the market: the institutions. They're the ones looking for bargains when the blood is flowing. This recovery should eventually help bring the wounded online traders back into the market, but it will be a slow process. I will be looking for gapping and huge swings to improve, which will be my signal for their re-entry into the game. Until then, as a momentum trader, I will focus on leadership stocks that institutions are always touting, such as
When institutions lead the market you must look for earnings, any stock that has beaten or is about to beat the Street, and undervalued stocks. I have a rule called the "law of participation." It means that I seek stocks that run with the leaders and pull back when the leaders pull back. They will gap much the same and mirror the action. Any stock that fails to measure up to the leaders are duds and I ignore.
This past week I've been playing stocks like
, allowing them to lead.
Last Thursday morning was a perfect example of following the
leader. Even though the
Employment Cost Index and
Gross Domestic Product numbers that came out weren't favorable, these numbers don't affect institutional buying as much as they do daytrader and online trading buying. The institutions have been touting how undervalued tech stocks are. Knowing this, prior to the bell on Thursday I put a group of tech stocks on my screen, including
, Oracle, Commerce One,
In my April 10 column,
Don't Buy Until You See Blood in the Streets, I discussed how I use
to give me insight on the immediate action of other stocks in that sector. Indicator stocks normally lead a group of sector stocks. They bounce and top out before the "follower" stocks. I simply watch indicator stocks, and when they bounce and climb $2 or more I start buying the follower stocks that are not far behind. When the indicator stock tops out, I exit from any trades in the follower stocks -- a very simple, yet effective technique.
On Thursday morning, I picked CheckFree Holdings, a maker of online bill-payment software and services, as my indicator stock because it had the most premarket volume, released very positive earnings and announced an e-commerce deal with the
Bank of America
. CheckFree opened at 43 and immediately climbed to 48 7/16, well above my $2 rule. Because of this "hidden" institutional momentum and sector interest, once CheckFree climbed more than $2, I started buying stocks such as Ericsson, MCI WorldCom and InfoSpace because they were participating in the indicator's momentum.
You can see from the charts below that the indicator stock led the pack up before the others had time to react. Because of this institutional pressure, all of these were held throughout the day, riding out the intraday oscillations. Short-term profit could be taken prior to the close or, using my "above-the-midline" rule, could be held for longer-term positions. The midline rule will be a topic for a future article, but simply put, if the stock closes above the midrange of the chart, it is a keeper until it closes below. See, I'm an investor as well as a momentum trader! I just combine momentum trading with the methods and techniques of investing.
There are two major parts to this puzzle. First, you must recognize and identify who is leading the momentum in the market, in this case the institutions. Second, identify the indicator stock that is going to lead the pack. After that, it's just follow the leader!
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