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Gaining Speed: Momentum Investing


A method of picking stocks that is closely related to technical analysis is momentum investing. Anyone who's ever parked a car on a hill but forgot to set the brake knows how quickly a moving automobile can pick up speed. That's momentum in action!

Momentum investors look for stocks that are moving at high speeds, on the theory that you can just ride out a stock as long as it continues to rise in price -- as long as you bail out before the stock crashes and burns.

Investors gauge momentum in one of two basic ways, by looking at the performance of a company's earnings, or a company's price. Momentum investors believe that those companies with the biggest price changes over the most recent few months are poised to continue making big gains. And companies that have earnings that are growing very quickly, say 30 percent a year or more, are also game for momentum investing. Some investors look for stocks whose earnings estimates are continually revised upward by analysts, or whose earnings continually surprise Wall Street by being higher than expected.

The risk in momentum investing is that these stocks are usually very popular with investors. That means that their prices and P/E ratios are probably already very high. The first time one of these stocks posts disappointing earnings, it will be quickly punished, and the price will drop just as quickly.

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