Narratives and Charts

Here at HX Daily, we share insights into some of the most powerful investing concepts and tools every Thursday.

Last week, we discussed short-selling and shared a straightforward metric that drives its success.

Today, we want to share a conceptual framework about “momentum” investing and how to harness it.

First – let’s start with the definition. What does it mean when we say “momentum” investing?

Go to Investopedia, and they share this definition…

“Momentum investing is a strategy that aims to capitalize on the continuance of an existing market trend. It is a trading strategy in which investors buy securities that are already rising and look to sell them when they look to have peaked.”

We think that first sentence is key. Momentum investing focuses on buying stocks that are going up already.

Many new investors gravitate towards momentum investing. They look for stocks making money and see if they can join the ride.

While more "sophisticated" investors might criticize this approach, we think it is actually the BEST one.

Our strategies aren’t based on momentum investing per se, but we only look to trade or invest in stocks and companies with both share price and operational momentum.

Why fight the waves? Figure out how to surf them instead!

The other day, we had an interesting dialogue regarding momentum investing on the HX Podcast. You can listen to that episode here or watch it here.

Investors are attracted to momentum stocks because they go up. They often go up a lot and do it sooner rather than later.

These same investors, though, can become very frustrated when these stocks quickly go down.

One of our views on momentum stocks is that they do NOT correct by going sideways. If they are not going up, they are going down.

In that podcast, we discussed how momentum stocks begin…

Usually, a stock starts going up as a “narrative” is built that appeals to a broad spectrum of investors. The "narrative" means the "story."

In the first half of 2024, the most popular narratives revolved around artificial intelligence.

The story must have real-world validity for momentum to persist and become actionable.

While we are in the early stages of AI today, it is undoubtedly impacting the earnings of some companies right now.

Here is this chart of the earnings revisions at NVIDIA Corporation (NASDAQ: NVDA) …

The AI story is strong, but the reality is that analysts' estimates for NVDA 2024 EPS have skyrocketed. Those are real dollars buying real chips.

This isn't just a "narrative" but also an economic reality.

What happens with momentum stocks is that a strong narrative – backed by fundamentals – attracts buying attention.

As more operational momentum builds and the narrative strengthens, it attracts more buyers.

With the stock going up further and developing into a strong uptrend, you are now beginning to attract a second group of buyers.

These are not “narrative” buyers but "chart" buyers.

They don't care about (or even know) the story behind the company and the stock. They are simply interested because it is a great-looking chart.

There is much money to be made with this strategy!

Typically, they find great charts and then trade them. They look to own them as long as they are going up. At points, they tactically alter their position and perhaps look to take advantage of consolidation or breakouts.

Most important, though, when the stock STOPS going up – they are sellers.

The only reason they were in the stock in the first place was because it was going up, so when that is no longer true, the trade doesn't interest them.

As a narrative builds and momentum stocks are born, the price can increase significantly. The combination of the original narrative buyers and the chart buyers piling on can lead to incredible returns.

We saw much of that in the stock market in the first half of 2024. Here is a list of the top returning stocks in the large-cap Russell 1000 over that period…

A dozen stocks posted returns you would be happy to see over a five-year period!

If you own any of these stocks, you had a great first half of 2024.

Many of these same stocks, though, have been down as much as 30% in the last few weeks.

What happened?

For most of them – absolutely nothing. We reached a point where the buyers were exhausted, and the incremental buying dried up.

When that happened – and the stocks stopped going up – the chart buyers decided to exit.

In momentum investing, strength begets strength. The higher a stock goes, the more momentum investors are interested in it.

The same is valid on the other side, though – weakness creates weakness.

What we have seen in these stocks is the inevitable rotation of momentum investors out of these stocks.

In the same way that upward momentum can create a half-decade of return in six months, it can also produce a BEAR MARKET worth of losses in just a few weeks.

What does that mean for you and your TRADING and INVESTING?

This type of price action creates great OPPORTUNITIES.

We are seeing what might be the single best buying opportunity of 2024 right now—the opportunity to buy the strongest stocks that are now down a lot.

Understanding the dynamic between “narrative” and “chart” buyers can help you harness momentum investing!