Risk Management = Momentum Strategy

There has been a lot of head scratching recently at the steep ascent of the market. Historically, this type of straight line movement is unusual but it has become common in recent years. The S&P 500 crashed 225 points lower in a little over two weeks, starting in late July. I believe the reason such abrupt movements have become common is the proliferation of momentum strategies.

Most hedge funds market themselves as having a value strategy when in reality they have a momentum strategy. They have "risk management" tools in place whereby they do not allow losses to grow and reduce exposure when they are losing money. In isolation this strategy works fine, but when everybody is employing the same strategy selling begets more selling. As markets move lower more hedge fund are forced to "manage risk", which causes markets to move even lower until everybody is de-risked. Once the market starts moving higher the opposite occurs, as we are currently seeing.

Many quant strategies use momentum as vital inputs. Twitter and the blogosphere are dominated by those who employ momentum strategies. With all these momentum strategies in place it is no wonder that we see these straight line movements. I have greatly adjusted my trading strategy to allow for this type of movement. As somebody who is value focused this means being more patient with both buys and sells. The good news is that for those that can keep their heads these awesome moves provide great opportunities.

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