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Momentum Stocks: Opportunistic Investors Should Be Cautious of Bull Traps and Falling Knives

Investors looking at high flying growth stocks have been waiting anxiously for a meaningful pullback, hoping to pounce on any significant dips. As many of these stocks have tumbled from their

Investors looking at high flying growth stocks have been waiting anxiously for a meaningful pullback, hoping to pounce on any significant dips. As many of these stocks have tumbled from their highs, bulls should approach these momentum stocks with the utmost care. Patience and discipline can be the difference between major losses and major profits. In this week's interview with Toni Turner of TrendStar Trading Group, we discuss signs to watch for when confirming a reversal, as well as key earnings on the docket. 

EQ: There's been a lot of talk in the market that momentum stocks are no longer in vogue. Do you agree with this? Is this a buying opportunity or should investors stay away as well?

Turner: A lot of the big momentum stocks have definitely pulled back recently. If you look at Facebook ($FB), LinkedIn ($LNKD), Amazon ($AMZN) and the others, I think prices got too far ahead of earnings. Facebook has a P/E ratio of 86 times 2014 earnings, LinkedIn has a P/E of 725, and Amazon has a P/E of 548. It doesn’t mean that their prices can’t go higher, but it does mean that a select number of investors and institutions won’t touch them because these stocks aren’t attractive at these valuations.

From a technical standpoint, these kinds of stocks are in downtrends. So at this point, they’re technically falling knives. Even if they move higher over the course of a couple days, it may just be a short-term bounce, much of it fueled by short-covering. So while intraday traders may be able to profit from quick rebounds, longer-term traders and investors need to make sure any reversal point has legs before establishing a significant position.

EQ: A lot of these stocks do represent promising long-term potential. You mention Facebook, Amazon, and there’s stocks like Tesla ($TSLA). Long-term investors may have been waiting for a buying opportunity for these names. Should they wait for a confirmation that a bottom has been established?

Turner: Absolutely. You want to wait until a substantial reversal is in place, otherwise, the shorts will come in and push price lower. A rebound of one or two days is certainly not a good enough signal that the downtrend in these stocks is over and a reversal to the upside will take place. We need more than that.

Don’t try to pick the bottom. The pain that could be suffered is just too great. I wait until I have an RSI moving higher, or maybe a small double-bottom formation where there’s at least a retest and hold of price, and I see potential buyers under price. Once I see that and indicator confirmation, then I go in with a small share size and a firm stop underneath the lows. If price cooperates, I’ll scale into the position, adding as the uptrend strengthens.

EQ: The S&P 500 touched 1897, just under the 1900 threshold, before embarking on its current slide. Does this suggest that there's heavy resistance at the 1900 level?

Turner: Large round numbers typically act as support and resistance in the market, particularly with major indices. So 1900 is a resistance number. Technically, it is also the 38.2 Fibonacci level if you compare it to the January highs. Now that the S&P 500 has moved right up to 1900, that establishes that level as real price resistance.

EQ: It held around the 1850 level, which served as support prior to the previous move higher. Is that encouraging for the market?

Turner: It is encouraging. The 1850 was from the December and January highs. So that is a floor, and as long as that’s the floor, that means there are buyers there. Should it be penetrated, we can look to 1840 as the next support zone.

EQ: Earnings season kicks off Tuesday. What are you anticipating as we head into Q1 reporting?

Turner: Tomorrow will be very telling,as we will see earnings from JP Morgan ($JPM) and Wells Fargo ($WFC) before the open. I also like Fastenal ($FAST) for Industrials.

Monday, we have Citigroup ($C) before the bell. We know they’re expecting to miss their profit goals.

Throughout earnings season, I’m going to be watching the Financial Select Sector SPDR ($XLF) to see if it can maintain the current highs and its uptrend on a monthly chart. The Financials have been very strong, and if they can maintain, then they can be the backbone for this market going forward. If they cannot, and if we see the yield curve continue to flatten, the market may be due for more weakness in the coming quarter.

EQ: Are there any sectors or industry groups that you're watching right now?

Turner: I’m watching the Teucrium Corn ETF ($CORN). Corn exports increased to the second-highest level of the 2013-2014 market year. .

I’m also keeping an eye on oil and the United States Oil ($USO), although the run-up in the last four days may produce a short-term pullback.  As long as the USO stays above its 50-day and 200-day moving averages will be worth keeping an eye on.

The iShares US Telecommunications ($IYZ) may continue to do well, as that group can be defensive, and may see continued strength if bond yields fall.  And as long as interest rates stay reasonably low, I’m watching the iShares US Real Estate ($IYR) and Utilities Select Sector SPDR ($XLU).

Copper, base metals, and industrial commodities face bearish technical trends, but the fundamentals remain bullish.