almost 3 years ago • 1 min
Since the start of the year, the performance of small investors’ favorite stock picks has closely tracked the returns from a strategy known as momentum trading, which bets that shares that have climbed fastest recently will continue to do best.
The chart shows the 30-day correlation between Goldman Sachs’s Retail Favorites index and Bloomberg’s US Pure Momentum Factor index – a measure of how closely the two measures have moved together over the preceding month. After spending most of 2020 at negligible or even negative levels, correlation between the two has surged to 86% in recent weeks.
This level of correlation suggests retail investors – an increasingly active and important part of the market – might be getting drawn into stocks displaying strong momentum characteristics. While this strategy – sometimes characterized as "buying high and selling higher" – can be profitable under the right conditions, when sentiment turns and stocks start falling it can lead to wave after wave of selling pressure as investors close their positions.
A market featuring a lot of momentum-inspired behavior can be susceptible to both sudden rallies and dramatic declines. Buckle up.
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