Short-Term Momentum in Stocks, Commodities, and Cryptos

Retail vs institutional investors

November 2021. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Developed markets have evolved from momentum to mean-reversion markets
  • Other markets like EM or cryptos are momentum-dominated
  • Likely explained by the distribution of retail vs institutional investors

INTRODUCTION

Markets evolve constantly, but they rarely change structurally. When they do, it is usually either due to new policies or products. Regulations tend to have a more immediate effect, e.g. when decimalization was introduced by the SEC in 2001. Product innovations like ETFs can change markets, but their impact is typically spread out across time.

The one constant is likely investors as it is questionable if they change at all. Given the technological advancements, today’s investors are the most informed ever. But fear and greed still seem to drive many markets.

However, we should differentiate between retail and professional investors, where the latter are assumed to act more rationally and less emotionally than the former. It is interesting to analyze if this thesis holds and whether markets have changed due to the rise of professional money management over the last few decades.

Most professional investors rely on models to justify buy and sell decisions. If a stock becomes too expensive, it is sold. If it trades too cheaply, it is bought. In contrast, retail investors primarily chase performance. A market dominated by professional investors should feature mean-reversion, while a retail-dominated one should exhibit momentum.

In this research note, we will analyze various markets by contrasting their momentum versus mean-reversion characteristics.

MOMENTUM IN DEVELOPED MARKETS

We begin our analysis by analyzing the short-term momentum characteristics of developed stock markets. Momentum is defined as measuring the stock markets’ return last week, and if positive, then go long, while if negative, then go short. The trade signal is delayed by one day and portfolios are created each day to achieve an implementable and robust trading strategy. However, we excluded trading costs, which would have lowered the realized returns.

We observe the short-term momentum dominated the US, Japanese, and German stock market