Net-Stock Voodoo

Uncharted territory relies on volume and momentum, but little else.
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Barely profitable

Yahoo!

(YHOO)

buys

GeoCities

(GCTY)

, a fledgling company that has yet to earn a cent in profit, for nearly $5 billion in stock. No one is concerned that stock in both companies soared after the deal was announced.

Crazy?

Last week, high-speed Internet provider

@Home

(ATHM) - Get Report

spent almost $7 billion to acquire

Excite

(XCIT)

, the No. 2 portal site. Both @Home and Excite boast of huge losses, but that didn't stop @Home from paying a huge premium to snap up Excite.

Crazy?

Numbers don't lie. Those who bet on the right Net stocks have won big --

America Online

(AOL)

rose 630% in the past 12 months,

Amazon.com

(AMZN) - Get Report

is up 1,148%, and

CMGI

(CMGI)

, up 1,179%.

In the past year or so, Wall Street's talking heads have shrugged their shoulders and shaken their heads in amazement at the upward momentum of these stocks. The Wall Street chorus line sounds something like this: "These Net stocks are overvalued. These Net stocks are trading on momentum alone. It doesn't make sense."

Fundamental analysis -- in which a company is valued on its past performance, its past earnings and the value of its real estate, cash and goods -- does not apply. Fundamental analysis is exactly what cannot be applied to Net stocks. This is a game for momentum players.

If fundamental analysis offers no guidance, then what does? The answer, increasingly, is technical analysis. Sure, its critics compare it to voodoo or insist it's no better than reading tea leaves or chicken entrails. But technical analysts rely on price and volume, and they use computers to predict stock prices. Just what momentum players look for.

"The notion of valuations and P/E is crazy," says Doug Fairclough, a founder of

Clearstation.com

, a Web site thick with technical analysis. "That's a factor for some people, but some people are actually just buying the stock, not the underlying company."

Look for volume. Momentum players love volume. And trading volume can tell you plenty about the price direction. Remember the selloff in Net stocks two weeks ago? The light volume suggested that buyers still outnumbered sellers, says Fairclough. "Just looking at the volume indicator graph is like looking for the balance of power in terms of buyers and sellers," he says.

The other key factor is to look at charts. Even investors who swear they don't use technical analysis wouldn't deign to look at a chart without a moving average on it. The moving average is the average of most recent closing prices of a stock. Fifty-day moving averages are standard fare. Thirteen-day averages are all the rage.

The problem with a simple moving average, according to the quantitative geeks, is that it weights what happened a long time ago equally with what happened yesterday. Is that any kind of standard to use on Internet time? Enter the "exponential moving average," which uses a formula to weight recent data. In the past few months, shares of network security provider

ISS Group

(ISSX)

have bounced back every time they've dipped below their 13-day EMA.

Sure, technical analysis may sound crazy, but right now what can you rely on?