Paul Tudor Jones II is one of the most successful hedge fund managers. He has never suffered a losing year. His fund has returned 23% annualized gain since its inception in 1986. Paul Tudor is a momentum trader, who believes that price move and trend unfold only because of investors’ behavior.
Markets have consistently experienced “100-year events” every five years. While I spend a significant amount of my time on analytics and collecting fundamental information, at the end of the day, I am a slave to the tape and proud of it.
I see the younger generation hampered by the need to understand and rationalize why something should go up or down. Usually, by the time that becomes self-evident, the move is already over.
There is no training — classroom or otherwise — that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market. There’s typically no logic to it; irrationality reigns supreme, and no class can teach what to do during that brief, volatile reign. The only way to learn how to trade during that last, exquisite third of a move is to do it, or, more precisely, live it.
Fundamentals might be good for the first third or first 50 or 60 percent of a move, but the last third of a great bull market is typically a blow-off, whereas the mania runs wild and prices go parabolic.
I have always asked myself what could drive a stock to rise substantially in a short time frame. What makes a stock to appreciate 30, 40%+ in a month. The catalysts are different. Some are fundamental (earnings), other are psychological (technical). I found out that the majority of these fast riders belong to one of the following seven groups:
1. Stocks of companies that received an acquisition proposal at hefty premium. Unless you are an insider or possess extensive knowledge about the trends in a particular industry, your chance of catching such a move is close to zero.
2. Beaten down stocks to levels, where they become an appetite bite for value investors. Such stocks have very high short interest on their float. I believe that bottom fishing is for investors with huge capital base and very long-term investing horizon. For everyone else the probability of catching a bottom is minimal.
3. Recent IPO’s of companies with solid earnings and sales growth, belonging to a currently hot sector. Companies that have key role in core industries.
4. Stocks of companies that have recently received FDA approval for a promising drug.
5. Stocks of companies that have recently received huge order for their products.
6. Stocks of companies that beat the analysts’ consensus estimate (if there is one) by a wide margin. Such companies report triple digit quarterly EPS growth and significant rise in sales. They come and blow out all expectations for the future. Market tends to respond enthusiastically to such news, sending the price of a stock in the sky on monstrous volume. A triple digit earnings’ growth is not sustainable and rarely lasts for more than several quarters. All I care about is, that during this period the stock doubles, triples and quadruples. The initial reaction to earnings’ surprise is indicative for the potential for future price appreciation of a stock.
7. Stocks, belonging to currently hot sectors. What makes a sector hot? It all starts when a company from that sector comes and reports substantial earnings’ growth than is unexpected. The company says that is very satisfied with its current quarter result and it mentions that due to positive changes in its industry environment, it expects to post even better profit in the following quarters. What happens after that? It is very likely that Wall Street will bid up stocks of other members of the same sector, even when the fundamentals of those other members are far from impressing. Investors’ expectation for future earnings is a key here.
I have noticed that 70% of all stocks that experience big moves in congested time frames belong to the last two groups. This is where I focus.