One of the risks of momentum trading is that markets that are hot are hot…until they’re not.
Momentum can be a flash in the pan or a sign of something more fundamental or longer-lasting. In the heat of the moment, though, it can be hard to tell the difference. Short-term traders need to position themselves accordingly.
Canadian pharma firm Valeant Pharmaceuticals (VRX) has certainly put the “mo” in momentum recently, rocketing around 85% since October 31. It tacked on more than 20% since just last Thursday—a four-day explosion that hurdled the stock to new highs for the year, and well above resistance dating back to late 2016.
The stock really began its tear after its Q3 earnings release on November 7—$1.04 per share, which blew away the $0.90 consensus estimate. The company has some important product launches and approvals on the near horizon: Before the end of the year sales of its glaucoma treatment, Vyzulta, are scheduled to begin, and the U.S. Food and Drug Administration is supposed to decide whether to approve the company’s ocular redness treatment, Luminesse.1
Options trading—mostly at-the-money December and January calls—has spiked this week: around six times VRX’s normal volume on Tuesday, for instance. VRX, it seemed, was in play.
A little perspective is in order, though. The weekly chart below shows VRX was trading above $260 in August 2015 before embarking on a scandal-driven sell-off (sketchy drug-pricing and accounting practices2) that saw the stock lose more than 90% of its value by the time it bottomed in April-May of this year. Hedge Fund Pershing Square, which had been a big backer of VRX during its debt-fueled acquisition phase, sold its remaining position earlier this year.3
Even the enormous rally of the past few days has left the stock at less than a tenth of its peak value.
Just how enormous was it? Well, in terms of the past four days, VRX has had rallies this size or larger (24%-plus) only 21 other times since 1994. In these cases the typical price action immediately after was not bullish: Four days later the stock was lower more than 70% of the time, with the typical loss between 2-4%. Results were similar after 15% or larger four-day up swings (91 examples), suggesting the momentum bus needed to stop at the filling station before it could sustain a longer move.
Doesn’t mean Valeant can’t keep punching to new highs, but it’s a warning that hot moves are susceptible to reversals, and that no trend—no matter how strong—moves in a straight line.
1 Bloomberg.com. Valeant Climbs to Its Highest Level in More Than a Year. 12/11/17.
2 Fortune. What Caused Valeant's Epic 90% Plunge. 3/20/16.
3 Fortune. Billionaire Bill Ackman Sells Disastrous Valeant Investment After Nearly $4 Billion Loss. 3/13/17.