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How To Play Red Hot Momentum Stocks Without Getting Burned – Mike Swanson

Gold closed up last week over $1800. That’s good and is likely to bring more buyers into gold stocks, to help stocks such as my top stock pick for this month, but right now most Americans still remained focused on trading red hot momentum stocks, especially if they are Robinhood traders. We are seeing crazy moves in some individual stocks take place in the market and the pace of these stock plays may start to quicken with the recent breakout in the Russell 2000. In fact, we may be entering a few months of market activity that will be as crazy for some of these stocks as what I saw with internet stocks in 1999.

People get drawn into these “meme” and newly listed stock plays, because they can make big moves in a single day, but without a strategy it’s easy to be caught buying in after the momentum fades and left holding the bag. For instance, two recent stock moves that have generated the interest of the masses are the HOOD stock and the Donald Trump SPAC play DWAC. Both of these two stocks are on the Robinhood top 100 most owned list, and I would not touch either one of them now. But, both had good entry points with two different chart patterns that I used to daytrade in 1999, that is likely to repeat in future similar plays for the next few months.

In my book Strategic Stock Trading, I have a chapter devoted to what I called the Two Fold Formula for buying stocks. One half of it is fundamentals, and the second half is a specific chart pattern in which a stock doubles from a low price and then consolidates in a trading range for 5-10 days. If it breaks out again it typically will put on a second big price gain similar in size to the earlier one. This pattern tends to appear after a big stock market drop or sector bottom in individual stocks for a few months.

It’s not really appearing in any stocks now, but from a daytrading perspective this type of pattern can be used to play crazy momentum stocks.

A problem with fad stocks and IPO’s is that you do not know for sure if they will really work ahead of time. If a stock IPO’s and opens up too high it can just sell off all day in a “broken IPO” and a few of these have happened this year, but the opposite happened with DWAC. On it’s first trading day it soared. Here is the DWAC chart.

Wouldn’t it be nice to have bought DWAC in the morning and sold the next day?

How would you know to buy it?

There is a simple pattern that plays out in the best momentum or “meme” stocks that work out like this.

It is this – after the open, the stock makes a big swing for 30-60 minutes and then goes sideways for 1-3 hours and consolidates. If it can breakout to go through that consolidation resistance price to the upside before the close it typically will rally huge into the end of the day and gap up the next morning. What happens after that, is a gamble. It could go up more or just lose momentum and dump, like DWAC.

Here is what DWAC did on its first trading day.

See how DWAC opened up at $12.73 on its first trading day?

It then rallied to $20 and then spent about an hour and fifteen minutes consolidating below $20.00.

It then successfully broke out to the upside to complete a “Two Fold Formula” day trading pattern.

The first move from $12.73 to $20 proved it had powerful momentum.

The successful consolidation provided a buy entry point, in which one could clearly define their risk once they bought with a stop loss order at the low of the day.

To play it, I would have bought once the stock broke through $20.00 around noon that day and then walked away from the computer and came back by 3:00 PM. If it was below my entry I’d sell and consider it a failed pattern, if it was up I’d hold and aim to just sell the next morning and take profits with no care of where it went after that.

These are not stocks to buy and hold as investments.

A key to this is the pattern has to materialize. You don’t just buy on the open and hope it happens.

The second pattern is what happened with HOOD. It had a huge gap up open on its first trading day and actually closed at a lower price then its open to make for a potential “broken IPO.”

But it did not break, as buyers came in over the next few days to create a new consolidation trading range between $38 and $35. That’s a narrow range for a potentially highly volatile brand new “meme” stock.

Once HOOD closed above $38 it triggered a massive rally that took it up so high that it briefly went over $80.00 a share. The whole idea in these patterns is to look for a successful consolidation period and then buy as it breaks out and sell for a big gain and walk away. Also I would not buy in the first hour of trading in a new IPO. If you did that with HOOD, trying to use the DWAC pattern you might have bought at $40 on that first hourly bar and sold on the close of that day if you used my strategy. There can be a lot of fake out moves in the first hour of a new IPO that can happen. So you need to really see what is happening after an hour or two before coming up with a trading plan, much less making a trade, in my opinion – otherwise one is just buying to fulfill a psychological need to feel like they must be involved in the stock.

And really, most of these type of stocks are JUNK!

HOOD and DWAC are not good investments here. The stocks are wildly overvalued and both companies’ long-term business prospects can be in doubt.

Remember, although both of these charts are not exactly the same, the key to both having a good momentum short-term trading point is a successful consolidation period after the first hour of trading in the stocks.

With the recent IWM breakout, and a still dovish Fed giving speculation a green light (reducing a not needed QE bond buying program means nothing when inflation is now annualized at 5% a year), these type of crazy momentum plays are likely to keep appearing in some select stocks over the next few months. We’ll have to keep an eye on the IPO calendar to see what might be potential plays like this.