By Michael Sincere
An orchestrated short-squeeze on GameStop and AMC Entertainment Holdings lured traders into the stock market last month for a chance to strike it rich. Some retail investors made small fortunes while a few well-financed hedge funds got smashed. Power to the small investor. Few of us have ever seen an organized raid by retail traders, and it worked.
In reality, fad trades work on occasion, but don’t confuse buying GameStop /zigman2/quotes/203755179/composite GME -0.12% , AMC /zigman2/quotes/200235402/composite AMC +7.31% or any other targeted stock with a trading strategy. As MarketWatch columnist Brett Arends wrote : “This is gambling, not trading.” He’s right. Many traders are treating the market like a lottery game. Some took extreme risks and won big. Many others, the ones you don’t hear about, lost fortunes .
If you’re looking for a less-exciting, less-risky approach, one that aims to build wealth over time rather than in a few minutes, consider trend-following strategies. They are not as sexy as chasing after momentum stocks, but they’ve worked for decades.
Going long is easier than shorting
After studying and testing the market for years, I have found that it’s much easier to go long than to sell short (betting that a stock or index will move lower). Although short sellers are necessary for a healthy stock market , for retail traders and investors, going long is recommended. This means buying individual stocks or index ETFs.
Obviously, during the next bear market, going long will be challenging, but you can still find strong stocks in strong sectors no matter the market environment. Nevertheless, in choppy markets, trends can reverse quickly so you must be alert.
Let’s discuss a couple of trend-following strategies you can use in a choppy, unpredictable market environment.
1. Buy stocks with relative strength
Even when the market is selling off, there are stocks with “relative strength” — shares that are moving higher while the overall market is moving lower. Stocks with relative strength are diamonds in the rough.
For example, stocks with relative strength last week included Abbott Laboratories /zigman2/quotes/203724446/composite ABT +0.88% and Blackstone Group /zigman2/quotes/203156858/composite BX +2.21% , gaining as the U.S. market declined. On Jan. 29, when the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.44% slid 620 points, down 2.03%, these stocks were among the gainers: Gilead Sciences /zigman2/quotes/210293917/composite GILD +0.63% , Qualcomm /zigman2/quotes/206679220/composite QCOM +1.30% and McDonald’s /zigman2/quotes/203508018/composite MCD +0.22% .
Just because a stock shows relative strength doesn’t mean you should buy it. It just means it should be watched and considered. You still must do your homework before buying shares, and that means checking both technical and fundamental data.
2. Buy stocks that are trending higher
On the days when the market looks ready to move higher at the open (study the futures market for clues to market direction), prepare to buy stocks on your Watch List (a list of stocks you are tracking). It’s easier to go long on the days when the futures market is pointing to a higher opening.
Warning: Avoid stocks that are set to spike more than 8% or more at the open. Those stocks tend to reverse direction after a few minutes (what I call “one-minute wonders”).
Following stocks in a bull market is a simple strategy that has worked extremely well. Although it’s exciting to chase after wild stocks that spike higher, this can easily end in disaster. That’s why using a less emotional trend-following strategy makes sense for many traders and investors. Although you probably won’t make big bucks quickly, as long as the market keeps trending higher over the long term, you can make the big bucks slowly.
Michael Sincere is the author of “Understanding Options,” Understanding Stocks,” and the forthcoming “Make Money Trading Options.”