Momentum Stock-Watching: Apple, SunPower

This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers.

Since being evacuated numerous times from both of my homes in the mountains of Northern California over the last few weeks, I have learned quite a lot about wildfire behavior and discovered that some of the action we have been seeing in hot stock sectors is surprisingly similar.

Sector movements in stocks tend to run in cycles. Sparked by news, we will see sectors suddenly ignite, and the upward momentum gains power until eventually dying off when the market loses interest and the next hot sector takes over.

We saw this in metal stocks, such as Nucor (NUE) and Arcelor Mittal (MT). We saw this in solar stocks, such as First Solar (FSLR), Canadian Solar (CSIQ) and JA Solar Holdings (JASO). And we also saw it in agriculture stocks like Monsanto (MON) and Potash (POT).

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One important factor affecting the behavior of a wildfire is the topography of the land. Fires travel very quickly uphill, and the steeper the slope, the faster it burns. The reasons for this are that wind is usually flowing uphill, and the fire is preheating fuel up the mountain when the smoke and heat rise in that direction. Once the fire reaches the top of a hill, it slows down and struggles.

This is the same thing that happens with hot sectors. When they are hot, and there is news adding fuel to the fire, they are travelling uphill very quickly. During that time, they become my "focus" stocks.

Fire Watch

If I am daytrading, I will be trading those focus stocks every day aggressively, buying every dip and riding the uptrend. When they gap up, opening above the previous day's closing price, I expect to see very minimal selling at open if the strength is continuing. So I will look to buy the first dip, and from there it should continue the uptrend, up above the open price, above the premarket high, and eventually above the previous day's high. Quite often they simply trend right up along the 50-day moving average. Any sign of weakness, and I will jump out again.

If I am playing a longer-term uptrend, I will usually go long the first day that the fire ignites, with a stop below that day's low. I like to catch them bottoming after a longer downtrend, on a day when they close strongly, with an increase in volume. From there, I just keep trailing stops up, making sure it closes upper range, never letting it hit below the previous day's low.

If you look at a daily chart of Vulcan Materials (VMC), it is a perfect example of what I am looking for. It had a steady drop over the last few months from around $84 to $50. Then it suddenly ignited at the bottom, with an increase in volume, and it has been up trending sharply over the last few days, from $50 to $65.

Unfortunately, it came into my radar too far off the bottom for a longer-term trade. It has had some great intraday swings though, so we have been playing this one for daytrades. Yesterday Jul. 17 it topped off around $65, dropped to $57, then bottomed and climbed again to $64. That is $15 potential in one day if you time it right. Can't complain there.

When to Change Direction

Eventually, though, all fires start to die off once they reach the top of the hill, and that is when we want to change directions and start shorting. Sounds simple enough, but how do you identify when you are arriving at the top of the hill?

The first sign is often a disconnection between the hot sector and the high-momentum stocks within the market. Apple (AAPL) is a good example of a high-momentum stock that has been generally participating in the market, often leading direction. So if I see AAPL gapping up, opening above the previous day's closing price, and the market in general gapping up, that is a bullish signal for a potentially strong day. If I then see the leading stocks in my hot focus sector gapping down on that day, against the market, that is a disconnection and the first signal of a dying fire.

The solar sector was a good example of this yesterday. Although the market was gapping up, we saw a disconnection in the solars, with stocks like JA Solar and SunPower (SPWR) gapping down, after the SPWR earnings report. SPWR had been rebounding in the last couple weeks, from $61 to $81, and JASO had climbed from $14 to almost $18, leading the market's attempt at a rebound. But yesterday we saw the disconnection before the market open, which told me that rebound might be over and that I should short solars early.

The next sign of a dying fire is when we see the hot sector selling down more than the high-momentum stocks. Let's say AAPL drops 50 cents from the open, bottoms and starts climbing, but at the same time I see the solars selling down double that amount, with weak attempts at bottoming. I would then consider them candidates for a short. And if they close the day down, that might be the top of the hill and the start of a downtrend.

Tinder

Even after fires have died down, they can smolder for weeks or even months. In Indonesia, smouldering peat fires have been burning underground for years, sometimes sporadically reigniting forest fires during dry seasons. The same thing can happen with previously hot stocks and sectors. So once the stock reaches the bottom of the hill again and starts to strengthen, we want to watch carefully to see if the fire will reignite.

A couple that I have on my radar for potential bouncing soon, for longer-term trades, are Monsanto, which has sold down from $145 to $112 in the last month or so, and Canadian Solar, which has dropped over the last month from around $51 to $30. Remember, though, I am a daytrader, so longer-term for me means days, not years.

CSIQ is still a bit early. It gave us a false alarm Monday Jul. 14 after raising guidance, but it hit resistance in the daily chart right at the 50-day moving average. So it turned into a great daytrade, swinging from $35 to $39, but I wouldn't want to hold it longer with that resistance directly overhead.

It is also very important to be aware of what is going on in the news, because news is what will ignite, or reignite, the sector fires. If oil is dropping, then solar stocks are probably going to as well. If there is flooding in the Midwest, you will want to keep an eye on the agriculture stocks. If hurricanes hit us, we will have a group of hurricane stocks in focus. If mad cow disease hits our meat supplies, you will want to watch beef restaurant stocks. Keep lists of previously active stocks grouped in sectors. The point is to be prepared and aware, because you never know when lightning will strike and create the next fire.

This was originally published on RealMoney on July 18, 2008. For more information about subscribing to RealMoney, please click here.

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