Healthcare Stocks at the All-Time High List

More than 150 stocks reached an all-time high price level at some point today. Some of the highest volume moves came from the Healthcare sector. It is not a secret to anyone that follows the stock market that this is the sector that has been substantially outperforming over the past month (up 7.8% vs $SPY up 2.2%).

Let’s take a look at some of the big recent gainers in the sector.

$RMTI broke out to a new all-time high on April 28. The volume on that day – 5 times the 50-day average. The stock never looked back. It looked extended all the way up. Despite the humongous volume today, the stock closed far from the upper side of its daily range. It looks vulnerable to a pullback here.

$TRNX had an unsuccessful breakout attempt on March 21. It gapped up and gave back everything during the day, finishing at the bottom of its range. The second attempt for a breakout was way more successful. April 26. The stock was already in an established uptrend (10day MA above the 20 above the 50dma).

Not every breakout to new all-time high is a reliable signal. There are three additional factors that will improve the odds of success:

1) volume: the higher the better; it is an indication of institutional involvement.

2) catalyst (directly related to an earnings announcement or a sector move)

3) base: breakouts from long sideways ranges indicate a major development that has changed the supply/demand dynamics.

In hindsight everything seems so easy and clear, but when it has to be applied in reality, it is much more difficult. The equity selection criteria is often based on a study of the past winners. What traits did they have in common before they started their move? The truth is that many other stocks that share the same traits as the winning stocks will fail. It is really hard to differentiate them at the beginning stages of a new trend. Not every high-volume breakout to new all-time high from a good base will turn into a major winner. No one knew that when $OPEN gapped to $30 in February of 2010, it will go to 120 in the following year. No one knew that when $NFLX gapped up to $60 in January 2010, it will go to 250 within 12 months. The more one stock appreciates, the more it is studied and the nature of its move analyzed. As the price rises, the number of myths and explanations of the catalysts behind the move multiplies. Some of them are right, some of them are wrong. In the grand scheme of things, they are all irrelevant.

The real secret sauce is called risk management. Proper equity selection will help you to find the big winners, the stocks with the most potential for price appreciation. Risk management will help you to ride your winners long enough to make a difference in your returns and to cut your losses quickly, so you stay and thrive in the game.

Should You Chase Momentum Stocks?

I have always been amazed by the line: “If you are already in it, keep raising your stops. If you are not, don’t chase”. Psychologically there is a difference as in the first case you operate from the position of strength, assuming that you already locked in some partial profits. Technically, there is no difference between the two approaches, as long as you use stops and go for high reward trades. There is a reason momentum stocks are popular among short-term traders. Momentum stocks tend to move in a wide range. When you risk 50 cents to make $2.00, you can afford to be wrong 70% of the time and still end up with a profit.

Positive Expectancy = 30%*2.00 – 70%*0.50 = 0.25

Why Momentum Investing Is A Contrarian Approach

It is said that the four most dangerous words in the financial markets are “This time is different”. History rarely repeats, but it often rhymes. The truth to the matter is that it is always different and it is never different. The hot investing themes and stocks change every few years, but the investors psychology and the price charts of the best performers always look the same.

Recently I stumbled upon a paper titled “Predicting the Improbable“. The line that made me the biggest impression as I was able to relate it to the stock market goes as follows:

People tend to adjust their expectations of future events based on only small pockets of recent experience. In lotteries they tend to under-select recently drawn numbers, only to get for them in a big way if the number is drawn repeatedly.

This is essentially how trend following works. At the beginning of a new trend, there is usually an abnormal range and volume expansion. At this stage most market participants are reluctant to buy because the stock looks extended. The sudden change of the supply/demand dynamics often causes a “freeze” reaction = doing nothing. No one is willing to chase at this point, despite the fact that breakouts of long bases often precede much higher prices over time. The expectation of mean reversion is natural as it would restore the “balance”. Most traders are waiting for some form of consolidation for two reasons:

1) clear level to place a stop
2) prove of institutional support

The first major breakout is always considered an outlier and most market participants intuitively will desire to short it or simply will stay on the sidelines. At the beginning of a new major trend, people tend to under-react. As the breakout is followed by higher prices and more breakouts, more and more people become believers in the validity of the new trend and gradually the fear of missing out become stronger than the fear of losing. That fear of missing out has a particular name. It is called greed among independent investors and career risk among institutional managers. This is the time when the market start to proactively discount and the dreams of future potential trump the reality.

What happens when a stock doesn’t form a base after a 20% breakout, but continues to rise? The more a stock extends above its base and major moving averages, the less natural it looks to the human eye. It seems counter-intuitive that the move can keep going. For those who already own the stock, psychologically it feels harder and harder to stay and continue to ride the trend. For those on the sidelines, shorting becomes more and more enticing. This is the time, when the perspective becomes increasingly important. If you look at a monthly chart of the best performing stocks for the past year or for any other year, you are likely to notice nice green candles, one after another. At the monthly chart, most of the great performers will constantly look extended from their base. The more you decrease your horizon and move into weekly, daily and hourly charts, the more evidence of consolidation you will find and therefore places to put your stop.

Very few are able to ride the majority of a trend. The common scenario is that there are different owners at the different stages of a trend and what is buy signal for one might be a sell signal for another.