In­vestors be­ware join­ing the ‘mo­men­tum trad­ing’ herd

The Daily Telegraph - Business - - Business Comment - garry white Garry White is chief in­vest­ment com­men­ta­tor at wealth man­age­ment com­pany Charles Stan­ley

‘Buy low, sell high.” Th­ese four words sum up the ba­sics of eq­uity-mar­ket in­vest­ing. How­ever, some of the big­gest mar­ket moves now in­volve a strat­egy of “buy­ing high, sell­ing even higher” as novice in­vestors use com­mis­sion-free trad­ing apps to buy the lat­est fash­ion­able shares.

Af­ter send­ing Tesla shares to the strato­sphere ear­lier this year, the lat­est com­pany to send mil­len­nial traders on apps such as Robin­hood into a frenzy has been East­man Ko­dak. This is all likely to end in tears.

Robin­hood is a US trad­ing app that of­fers com­mis­sion-free trad­ing and has im­mense pop­u­lar­ity among mil­len­nial and gen­er­a­tion Y traders. The av­er­age age of app users is 31 – and it ap­pears that many young Amer­i­cans flipped their gov­ern­ment stim­u­lus cheques into eq­ui­ties us­ing such apps. Re­search by US data ag­gre­ga­tion group En­vest­net Yodlee found that trad­ing stocks was among the most com­mon uses for the gov­ern­ment stim­u­lus pay­ments in nearly ev­ery in­come bracket.

Un­like other bro­kers, Robin­hood is open about what its plat­form users are buy­ing, reg­u­larly pub­lish­ing trad­ing data. This means it can de­scribe it­self as more “trans­par­ent” than other plat­forms. But the data also adds to the mo­men­tum in in­di­vid­ual stocks – if ev­ery­one know the lat­est com­pany that is in fash­ion on the trad­ing app, it en­cour­ages other in­vestors into the trade, in­creas­ing the mo­men­tum.

Its forms a sort of un­vir­tu­ous cir­cle that will in­evitably blow up bub­bles that will rapidly de­flate. Th­ese bub­bles ap­pear to have – at least in part – been funded by the US gov­ern­ment.

Shares in East­man Ko­dak ral­lied al­most 1,200pc over two days re­cently and it be­came the most-traded com­pany on Robin­hood. This fol­lowed news on July 28 that Ko­dak had se­cured a $765m (£572m) gov­ern­ment loan un­der the De­fense Pro­duc­tion Act to un­der­take the pro­duc­tion of in­gre­di­ents for generic phar­ma­ceu­ti­cals to treat Covid-19.

Th­ese in­clude hy­drox­y­chloro­quine, a drug that has pre­vi­ously been used to treat malaria and that Don­ald Trump has sug­gested could be ef­fec­tive in treat­ing Covid. How­ever, Dr An­thony Fauci, a lead­ing mem­ber of the White House coro­n­avirus task force, has re­peat­edly said hy­drox­y­chloro­quine is not ef­fec­tive against the virus.

Fur­ther­more, yes­ter­day the stock col­lapsed about 40pc on re­ports the US gov­ern­ment was block­ing the loan.

None the less, Robin­hood traders had em­braced the story and were buy­ing into the shares with zeal. The SEC has now un­veiled an in­ves­ti­ga­tion into how the deal was an­nounced, as there were a sig­nif­i­cant num­ber of trades on the day be­fore the news was of­fi­cially re­leased.

East­man Ko­dak has a bit of a his­tory of piv­ot­ing to­wards trendy in­vest­ment fads. A cou­ple of years ago it tried a “pivot to Blockchain” – some­thing that was also caus­ing share prices to ex­plode. Per­haps Robin­hood buy­ers of the shares don’t re­mem­ber this his­tory.

The rise of the dig­i­tal pho­to­graph and smart­phone has meant that East­man Ko­dak has been a com­pany in search of a new busi­ness for quite some time. In Jan­uary 2018, it an­nounced a part­ner­ship with Wenn Dig­i­tal to launch a dig­i­tal cur­rency and blockchain-based plat­form, with an ini­tial coin of­fer­ing (ICO) ex­pected at the end of Jan­uary.

The Ko­dakCoin an­nounce­ment dou­bled the price of Ko­dak shares but none of it came to pass. Be­fore the Covid story, the shares were trad­ing at about a third of the level seen be­fore the Ko­dakCoin an­nounce­ment. This should all make in­vestors cau­tious.

But his­tory is ir­rel­e­vant for mo­men­tum traders – as are fun­da­men­tals. It is a trad­ing strat­egy in which in­vestors buy se­cu­ri­ties that are ris­ing and sell them when they ap­pear to have peaked. Then, the in­vestor takes the cash and looks for the next short-term up­trend and re­peats the process.

Of course, so-called mo­men­tum trad­ing isn’t new. Its most fa­mous pro­po­nent was prob­a­bly Richard Driehaus, who gen­er­ated im­pres­sive re­turns in the Eight­ies and Nineties us­ing mo­men­tum strate­gies based on re­sults “sur­prises” as buy and sell sig­nals. But the cur­rent mo­men­tum traders are not us­ing fun­da­men­tal data – they are look­ing at lists of pop­u­lar stocks and try­ing to ride the wave. The prob­lem with mo­men­tum in­vest­ing is that moves could be just as rapid on the down­side as they are on the up­side.

Some say that th­ese new mil­len­ni­al­gen­er­a­tion traders are re­spon­si­ble for

‘The prob­lem with mo­men­tum in­vest­ing is that moves could be just as rapid on the down­side as they are on the up­side’

send­ing mar­kets up since the lows hit in March. It is true that eq­ui­ties are trad­ing at lev­els that im­ply fu­ture earn­ings are go­ing to be sig­nif­i­cantly higher than they are likely to be. But this ef­fect ap­pears to be cen­tred on a lim­ited num­ber of shares.

In June, Bar­clays pub­lished a study of moves in the S&P 500 and po­si­tions taken by “Robin­hood­ers”. It con­cluded that re­tail in­vestors spec­u­lat­ing in stocks are not re­spon­si­ble for the mar­ket’s rally and the top picks of the app’s users tended to un­der­per­form and moves in the S&P 500 were in­de­pen­dent of the po­si­tions taken on th­ese apps. Nev­er­the­less, some of the most pop­u­lar stocks traded on the Robin­hood app have been some of the big­gest win­ners in the mar­ket – but cor­re­la­tion is not cau­sa­tion.

Of course, there will be some Robin­hood­ers with big gains. How­ever, this strat­egy needs a lot of at­ten­tion to fol­low mar­ket moves and it seems in­evitable that most will even­tu­ally lose money. But de­spite their “fol­low the herd” strat­egy, they are not the main driv­ers of the mar­ket as a whole.

Dr An­thony Fauci, a lead­ing mem­ber of the White House task force, has re­peat­edly said hy­drox­y­chloro­quine is not ef­fec­tive against the virus

Newspapers in English

Newspapers from UK

© PressReader. All rights reserved.