Want to see a good example of how momentum and euphoria can drive trading? You don’t have to go back to late 1999 and early 2000 to see an example.
I was going through my technical screens searching for stocks with high Relative Strength above 90. I generally like trading stocks with high Relative Strength, as they are full of momentum. You want to ride the upward momentum, but, at the same time, be alert when the buying fades and traders head for the exits. Remember the “following the money flow” idea, which I discussed yesterday.
I previously talked about the need to see rising volume on rallies. Without this, the sustainability of a stock would be an issue.
My screen search yielded Internet mega-search engine Google Inc. (NASDAQ/GGOG). Since making its debut last August 19, 2004 at $100, the steroid-induced stock has been nothing but spectacular, closing at $256 on Tuesday. That’s an incredible ride for those long in Google.
Trading at above its 200-day and 50-day moving averages of $198.95 and $206.15, respectively, the near-term technical signals are presently bullish with strong rising Relative Strength.
Sounds good, but do you jump in now given the price appreciation? Goldman Sachs just reiterated an outperform rating on Google. When brokers are bullish after a strong ascent, it is a red flag.
The short-term trend is positive, but, given the recent buying, the stock looks extremely technically overbought and due for a pullback. So, how do you play a momentum-induced stock like Google? In the absence of a mid- and long-term trend because of the stock’s short history, trading Google is a high risk. The downside risk is greater than the upside potential.
If you just base your trade on the fundamentals, then you would probably sit on the sidelines. Trading at 101x earnings and 50x its estimated FY05 EPS, Google looks very rich.
Less than one year into its debut, Google currently sits in 31st place on the Dow, based on its whopping market-cap of $71 billion. This places it just behind Merck & Co. Inc. (NYSE/MRK), but ahead of other Internet bellwether stocks such as Yahoo! Inc. (NASDAQ/YHOO) and eBay Inc. (NASDAQ/EBAY). Google is also ahead of established Dow components including American Express Inc. (NYSE/AXP), Hewlett Packard Co. (NYSE/HPQ), and Boeing Co. (NYSE/BA).
I view the buying in Google as euphoric and somewhat irrational. You can trade the trend on Google, but due to its extremely high volatility, you only want to play with risk capital. While the near-term trend is bullish, the stock is clearly set for some selling. The chart shows key technical support at $200, a 22% retrenchment from the current level.
So trade it if you must, but I’d rather sit on the sidelines on this one.