Friday, November 27, 2020

Momentum is everywhere - can even be found intraday


Momentum is everywhere, in every market sector, and for all timeframes. It can even be found across weeks, months, and intraday. The behavioral reasons for momentum transcend all markets. There are also structural reasons based on the hedging behavior of traders that will also drive momentum. This does not mean that momentum will work at all time and in all markets, but the odds are in your favor.

A new paper "Hedging demand and market intraday momentum" focuses on intraday momentum that is based on the hedging demand of traders that have to rebalance their risk exposures. There has been a strong view that momentum is a behavioral issue. Investors have a slow reaction to news. However, there also is momentum created from hedging demand associated with specific strategies. For example, option replication like portfolio insurance will create price momentum. Similarly, the rebalancing of option hedges will create momentum as traders offset gamma risk. A short option position that needs to be hedged requires buying when prices are rising and selling when prices are falling. If the demand for hedging is large enough, market prices will show intraday momentum.

The authors of this paper focus on intra-day adjustments across a set of over 60 markets and four asset classes with a sample of close to 45 years of daily data and finds strong intra-day momentum that is consistent with the strong demand for hedging short option exposures. The rest of day (ROD) has an important and statistically significant impact on the last half hour of trading (LH). This effect is especially significant for equity markets that have strong option demand and levered ETFs. The hedging demand is focused on the last half hour to avoid carrying overnight risk on short option positions. 

The research shows that the intraday effect is especially strong for equities and commodities. The impact is less for currencies where the last half hour of trading is less clearly defined.

The intraday effect declines significantly as we add time intervals. The effect is focused on hedging action before the end of the day.

The rest of the day impact is strong across all asset classes and significant relative to other configurations.

Momentum has structural as well as behavioral drivers. An intraday effect suggests that trend-followers and momentum traders can mix and match different timeframes to improve the overall performance of a momentum portfolio. 

No comments: