Originally published in the National Post, January 18, 2014

Wouldn’t it have been nice to own Plug Power Inc. (PLUG/Nasdaq), up 144% so far this year, or Ballard Power Systems Inc. (BLD/TSX) up 237% in the past year, and 47% so far in 2014?

Of course it would have. We received a lot of questions this week from customers about high-momentum stocks such as these. Every investor, it seems, wants in on some of the action.

We are not necessarily recommending the two stocks mentioned above, but we are strong believers in the power of momentum. You need to be careful, though. Sometimes momentum makes sense, and sometimes it sets you up for a disaster.

Regardless, keep in mind momentum works both ways: You can profit handsomely very quickly, or get your portfolio destroyed just as fast.

Let’s take a look at five important things to consider if you wish to get involved with momentum stocks.

Earnings acceleration

It is important to look beyond just the stock price of a momentum play. You want to see an underlying acceleration in earnings growth. A company that does better than expected, such as Badger Daylighting Ltd. (BAD/TSX), attracts a lot of attention. Why are earnings so strong? What are they doing right?  Figure it out before investing.

Analyst revisions

As a company reports stronger earnings, analysts, of course, fall over themselves to extrapolate faster growth and revise their target prices upwards on companies. These analysts start pounding the table on recommendations, causing more investors (institutional) to take an interest in the company and start buying.

Bloomberg has a great function key on analysts’ revisions, showing the degree of earnings estimate changes. It can be an important factor in trying to determine which stocks might catch momentum.

Market cap changes

As a company’s stock price moves up, its market cap changes right along with it. As a company transitions to new levels of capitalization, more investors become interested. More institutions can buy a $500-million company, than can buy a $100-million company. Thus, at certain levels, there is additional stock buying only because a company is larger.

As a momentum investor, this upward move is great, and results in a better valuation of the same company. For example, Chemtrade Logistics (CHE.UN/TSX) this week raised $300-million in a bought deal, raising its market cap above the key $1-billion level. Its stock, incidentally, had a big move when the financing was announced.

Technical and volume indicators

We will leave this largely to the chartists, but there are often significant technical moves that indicate a momentum breakout is real.

There are too many signals to list, but we look most closely at volume. When a stock with momentum shows increasing and consistent volume, the move is less likely to be a head fake. Large daily volume increases accompanied by a new high on a stock is a very strong signal.

Shifting valuations overall

More upside momentum is obviously generated by a rising stock market and investor confidence. If overall valuations are increasing, it makes sense for stocks that have strong earnings growth and upward analyst revisions to go up at a faster rate. If investors like everything, they should like the leaders more.

Right now — with the economy improving and the market doing very well — is an ideal time to try to pick away at some momentum stocks.

Once you are in, though, the key is getting out.

Momentum strategists advise you not to do anything until something changes to the negative. It is important to ride the positive curve as long as possible.

On the first negative earnings surprise or analyst downgrade, it’s time to get out. You may take a hit on the bad news, but if you have ridden the momentum well, you should still be well above your purchase price.