Momentum trading is a great investment strategy for those investors who know when to get on board and when to jump off the bandwagon. Too often though investors are burned when their impressive gains quickly fade away in the aftermath which is the crash.
Performing technical analysis can help to identify how and why momentum stocks fly and die. Everything comes back to investor psychology, and technical analysis is just one way to translate it into legitimate buy and sell signals.
Below is one recent example I found with Travelzoo (TZOO) stock. The stock ran from $20 to $103.80 in less than eight months then over the next five fell all the way back to its initial price levels around $20. Below is TZOO's stock chart with key points broken down.
1. Travelzoo Inc jumped off an impressive earnings release. This was one of the main catalysts that really strengthened the number of institutional investors holding the stock. These institutional investors only further fueled the price rise in future months. Note that TZOO broke out of a four month base in September 2010 (not shown) which was its original foundation.
2. A mini inverse head and shoulders breakout which lead the stock on its parabolic move higher. Key point here was the formation of the head. Notice how the stock broke under its December lows and marked "lower lows". These types of fake outs are designed to shake out weak investors by triggering their stop losses prematurely. Being in that position overall stinks to put it lightly.
3. The climax top comes as the stock gaps on record volume (up to that point) to fresh 52 week highs. Massive gaps like this one are often marked as exhaustion gaps as they very typically come right before or at the top of parabolic moves. Note however there are many other common topping formations; this is just one example.
4. Travelzoo breaks out of a nice 2.5 month consolidation in expectation of strong earnings, but once released, the stock gapped heavily to the downside on record volume. This was more or less the beginning of the end of TZOO.
5. As the stock declined you can see how lowers lows kept coming into play and previous support became resistance. As is the case for many momentum train break downs, the rise is quick, but the fall is even quicker.