Why Investors Should Avoid Momentum Stocks

Although this strategy is popular with daytraders, MoneyShow’s resident technician Tom Aspray demonstrates why investors should steer clear of momentum plays.

The rally continued on Monday, and though the market internals were not quite as strong, the McClellan Oscillator rose further to +81, but it is still below the early April high at +88. The Dow Transportation Average once again led the Industrials as it is approaching the all-time highs. The S&P 500’s five-day winning streak is the longest since last October.

The S&P futures have had nice gains since last week but their volume has been declining over the past three days, consistent with a loss of upside momentum. Therefore, I am looking for at least a short-term pullback in the next few days. This should be a buying opportunity in those stocks and ETFs, which are positive technically like the two large-cap ETFs I recommended last week.

Such a correction would help soothe the market bears and encourage some traders to bottom fish in the beaten-down biotech and Internet stocks. The market is focused on the widely anticipated earnings on Thursday from stocks like Apple, Inc. (AAPL) and Facebook, Inc. (FB), but several other big names report today and tomorrow.

Many investors are often tempted to buy some of the high-flying momentum stocks that traders love. A look at the charts of Chipotle Mexican Grill, Inc. (CMG) or Intuitive Surgical. Inc. (ISRG) will make it clear how they could seriously damage a portfolio’s performance.

Click to Enlarge

Chart Analysis: Chipotle Mexican Grill, Inc. (CMG) hit a low of $233.82 in October 2012, and by the March 2014 high of $622.90, it had gained 166%. This meteoric rise made it a favorite of traders but those on the long side have been punished over the past six weeks.

• CMG was testing its weekly starc+ band at the March highs (see arrow), but the following week it reversed to close well below the prior two-week lows.
  
• With Monday’s close at $506.54, CMG is now down 18.7% from its March high.
  
• The next key support is in the $480 area, line a, with the weekly starc- band at $487.53.
  
• The weekly relative performance did confirm the recent highs before dropping below its WMA.
  
• The uptrend in the RS line from the 2012 lows, line c, has now been broken.
  
• The OBV has also violated its support, line d, and is now well below its declining WMA.
  
• There is first strong resistance now in the $532-$538 area and then at $557.27, which is the quarterly pivot.
  

The volatility last week illustrates how wild a ride the stock took in just a few days. The 15-minute chart of Chipotle Mexican Grill, Inc. (CMG) goes back to April 15 as it reported impressive earnings on April 17.

• The stock closed at $552.02 on the 16th and then opened at $582.70 the following day in reaction to its earnings.
  
• It was trading above the starc+ band and formed a doji at 11:00 am.
  
• Just 45 minutes later, an LCD sell signal was triggered as CMG plunged almost $22 below the high from just 30 minutes earlier.
  
• The word on the street was there was concern over menu price hikes.
  
• The short-term chart support at line f was broken 30 minutes later.
  
• Another 30 minutes later, the intra-day relative performance violated support and started to plunge.
  
• The on-balance volume (OBV) confirmed the break of price support as it dropped below its WMA (point h).
  
• By the end of the day, CMG closed at $519.61 and dropped down to $506.54 on Monday.
  
• This was a drop of almost 14% in 1½ days of trading.
  

NEXT PAGE: 1 Momentum Stock Reporting Today

Click to Enlarge

Intuitive Surgical, Inc. (ISRG) is another well-known, high-priced, high-flying stock. The stock made its high of $594.89 in April 2012 and then retested those highs in early 2013.

• The double top formation was confirmed in the middle of July of 2013 as the uptrend, line b, and the support at $505.66 was broken.
  
• ISRG eventually hit a low of $351.14 last December and a high close doji buy signal was triggered the following week (see arrow).
  
• The relative performance surged two weeks ago as ISRG hit a high of $541.23 and traded well above its starc+ band, putting it in a high-risk buy area.
  
• ISRG surged 13% in one day in reaction to the approval of its robotic surgery apparatus.
  
• The stock reversed the following day and the next week gave up all of its gains.
  
• The weekly OBV just reached its downtrend, line e, and has now dropped below its WMA.
  
• The next support is in the $400 area with the quarterly projected pivot support at $384.52.
  

The 60-minute chart of ISRG shows that it has closed at $437.99 the day before the news hit the tape, and it opened at $486.05 the following day.

• ISRG traded several times above its 60-minute starc+ band over the next two days and the daily starc+ bands (not shown) were also exceeded.
  
• The relative performance peaked on the April 3 close but dropped below it the following day.
  
• The RS line has since formed a series of lower highs, so far, this month.
  
• The hourly Aspray’s OBV Trigger (AOT) peaked on April 2 and formed lower highs as prices moved higher.
  
• This bearish divergence was confirmed by the drop below zero on the April 4 close.
  
• The stock eventually hit a low last week at $410.02 and closed Monday at $411.11.
  
• It has dropped 24% in just 11 days.
  

What It Means: Intuitive Surgical, Inc. (ISRG) received a number of buy recommendations in early April, and it reports earnings after the close today.

Also, there have been a number of bullish articles on Chipotle Mexican Grill, Inc. (CMG), and I think that these examples demonstrate why they are likely not appropriate for most investors. It also illustrates why it is best to always keep one’s portfolio exposure to any one stock at low levels.

If either stock was a large holding in your portfolio, the damage recently could have erased the majority of last year’s gains. That is why I emphasize calculating the risk on each position before, not after, you buy.

How to Profit: No new recommendation.