How To Avoid High Flyers About To Hit Turbulence

Tue 1:30pm by Mark Simpson

19 comments 785 reads

We all know the feeling. An otherwise smooth flight is interrupted by a couple of bumps. We hear a bing-bong, and the seat belt sign comes on. The cabin crew ask us to return to our seats. We are in for a rough ride.

It is the same for our high-flying investments. High-quality companies with strong momentum can be one of the fastest ways to reach our investing destinations. However, they also come with a significant risk of turbulence. Companies that are flying high have much further to fall when atmospheric conditions change. With turbulence on a plane, we are along for the ride, whatever comes our way. Not so with our investments, where we are mainly free to sell whenever we choose. Is it possible to get out at the right time?

Is there a bing-bong moment for high-flying investments?

There is a market saying that “nobody rings a bell at the top or the bottom of a market”. This is true. No investor consistently gets in at the bottom and out at the top. However, investors who get out when the seatbelt sign comes on following those first few bumps will do much better than those who need to reach for the sick bags.

Given the value of this potential insight, the team at Stockopedia have spent a significant amount of time trying to answer this question. A few weeks ago, I looked at the effect of investors avoiding the lowest-ranked stocks on their least preferred measure. The answer was pretty clear for Contrarian investors who like cheap, high-quality stocks. They should fight their urge to go completely against the crowd and would do better (at least in our simulations) by avoiding stocks with terrible momentum characteristics.

However, the case for investors in High Flyers avoiding the lowest Value-ranked stocks is not as clear-cut. There are times when this would have worked (most notably during the recent weak UK markets). However, overall, there was no clear advantage to this, as the following chart, which splits high QM stocks into V-quartiles, shows:

Last week, Roland asked if falling Momentum could be a warning sign of trouble ahead. He gave interesting examples of Bunzl (LON:BNZL) and Celebrus Technologies (LON:CLBS) , where the drop in Momentum Rank signalled concern before some big falls in the share…

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WarrantStar

Wed 8:32am

Mark, Thank you for this very interesting piece of work. You conclude that it might be a good sell signal for a High Flyer when the share price is going up, but the Momentum rank starts to drop. When we examine how the the Momentum rank is arrived at, we can split the data into two groups, ie share price data, and fundamental data such as earnings. So we could say that when the share price is rising and the Momentum rank is falling, then it must be the fundamental (earnings) data which is falling. Therefore one could postulate that the High Flyer sell signal that we should look for should be the fall of the fundamental earnings data?

iwright7

Wed 9:39am

Mark

I think that this is a fascinating topic and I was intrigued by the Warpaint London (LON:W7L) e.g.

“However, the major portent of poor future returns is the divergence between the Momentum Rank and share price. The Momentum Rank fell precipitously seven weeks before the share price mirrored this behaviour.”

So using the Print function I went back to July-Sept 24 for SP MR and Earnings forecasts nos and worked out the average M Rank/ month, which are:

July 99M - peak price

Aug 97.5M

Sept 96.4M

So not a large M Rank difference, unless my maths are wrong, or is there a blue line interpretation issue?

Rusty2

Wed 10:13am

Yes the M score was still over 80 in January 25, the big share price fall happened early February. The share price had been over 500 for a while with the M scores still quite high, in November and December 24, l'm not seeing a precipitous M fall until after the share price fell. There was a drift down. Many M scores follow the share price. M was 86 on 15/12/24. M was still 83 on 29/12/24, share price 528p.

Yes you find examples like this but l bet there ones with the opposite behaviour. Some investors buy the dip and share price does recover often after some consolidation, of course the Momentum scores will fall, during that period. Some shares will fall further.

Alumasc (LON:ALU) could have sold at 320p, share had fallen, M score falling but now back up to 375p, M score up again. OK probably much better examples can be found.

Peter171

Wed 10:31am

Good old fashioned DMAs very rarely let me down after a stock high dips below a higher DMA is a good time to sell. At least one is realising a profit!

Wed 10:52am

Looking Alpha International (LON:ALPH) early April share price 2300, M score 76, now share price over 3,000p, M score only 56. I know it is not a high flyer. Can see similar pattern in 2024 with this stock.

Wed 11:00am

Yes although quite a few will fly higher. Then you miss out on the big multi baggers.

Wed 11:09am

Mortgage Advice Bureau (Holdings) (LON:MAB1) could be a good study, over the last 10 months.

Epitychia

Wed 11:22am

Thank you for a great article.

The momentum literature almost all agrees that price momentum only lasts on average for a year. Therefore any stock that has had a strong momentum score for a year should be reviewed.

This review should involve an assessment of the current direction. As Peter 171 says, looking for a divergence between a fast moving price moving average e.g. 10 days and a slower one e.g. 100 days would reveal a change in momentum / direction.

A fast and dirty way would be to use old fashioned moving stop loss.

Of course if you have the fortitude of Buffett then if you think the business case continues to be strong you simply ride out price falls. Personally i can't do that.

JCPr

Wed 11:50am

Interestingly, Next (LON:NXT) seem to match the criteria at the moment - assuming I understand the article correctly.

Wed 12:05pm

Next (LON:NXT) could have sold yesterday as M score went down to 78 but today it is up to 81. If l held l would consider selling some, judging by the charts.

Mark Simpson

Wed 12:51pm

Sorry for not being clear about this, I'm not saying the divergence would have got investors out at £6, but at £5ish when the Momentum Rank started to fall precipitously before the share price fell down to £3ish. Not perfect but still much reduced losses. No need for the print function. The Ranks are in the graph in the article, if that is what you are after.

Wed 12:59pm

I think that is one of the factors at play here, the clue is that the Value Rank also drops on average, suggesting that this is part of the story. Although the number of things that go into the momentum rank means it may not be the only part.

In general, I think the story is that a sharp rise in price in a High flyer that is not met by earnings upgrades is bad news.

Wed 1:07pm

Hi Mark, l'm not seeing that in the prints out, is your chart correct? As l said in my earlier post. 7 weeks is about mid December? 19th Jan, M was 80.

Don`t let the tail wag the dog

Wed 3:55pm

Mark, it would be interesting to know why Stockopedia calculate momentum using several earnings growth figures, which maybe more suitable to a growth indicator. It may be more useful if we had a separate price momentum indicator, which would probably be more useful as a stop loss indicator for people who use technical analysis. Moreover people who want to combine price and earnings momentum could still do this by using a combined growth momentum indicator. Maybe the growth indicator needs to be modified as Stockopedia hardly talk about it, yet surely growth is an extremely important reason a share may increase in price over time. Furthermore I cant see any research into the growth momentum indicator which you currently have. We can see how quality/value, value/momentum and quality momentum do over time, we can also see how growth does on its own, but how about combining growth and momentum. Maybe Roland, yourself or one of the other Stockopedia staff members who has access to past data could look into growth momentum and inform us whether it works or not.

Silver Moon

Wed 4:48pm

Sorting through my portfolios Mark (sigh, so many Sucker Stocks) I see Plus500 (LON:PLUS) is a High Flyer. I regret top-slicing it last month, wondering now if it will move up a Style to Super Stock and will choose to top-slice some more it it moves down a peg to Neutral. What say you?

Wed 7:58pm

Jan 19th it looks like the momentum rank started falling:

And we had up to 5th Feb to sell. So you are right, I think I am out on that 7 weeks, it was more like 3. Sorry.

Wed 8:02pm

Realistically, I don't think anyone is going to change the Momentum Rank as it is working. In my personal opinion, each of the ranks has an implementation that I wouldn't have done personally. But given the benefit of a long history of consistent ranks, and that they do a good job in most ciircumstances I doubt they will change. I beleieve the original implementation Ed went for was QVGM but the growth part detracted from the performance, as most quant growth measures do!

Wed 8:09pm

Most high flyers won't become Super Stocks as it would require a big one-off jump in earnings etc. that isn't reflected in the price, or at least only partially. No one knows when PLUS will top, but the research here suggests that you should be wary if there is a big spike up in share price that isn't due to changes in fundamentals, so the momentum rankstarts to drift and the value rank goes down.

I see little sign of this in the short term, despite a bit of exhuberence int he share price in the last month or so:

Wed 9:00pm

I accept the consistency argument with the Momentum Rank. The issue is the Growth Rank doesnt work, and it seems Stockopedia has abandoned it to a hidden corner of the platform. Also would the Growth Rank work better if you incorporated the earnings ranks you use to calculate the momentum rank, as from looking at the Stockopedia Academy the growth rank doesnt seem to use this at all. Even without changing the growth rank I just thought it might be a good idea to see whether growth momentum combined is a feasable strategy as its certainly worked for someone like Mark Minervini.

How to avoid High Flyers about to hit turbulence

Is there a bing-bong moment for high-flying investments?

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Mark Simpson

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