The Price of Crowding Into the Same Stocks: 10.8% in One Month

The Price of Crowding Into the Same Stocks: 10.8% in One Month

In October a portfolio tracking the stocks that had gone up the most fell 10.8%, the worst month in a series that starts in 1985. The single-day move on 22 October was more extreme still, worth about six and a half standard deviations.

Momentum is not an industry or a type of company. It is a rule: buy whatever has performed best recently. The trouble is that so many investors follow the rule that their holdings end up looking identical.

■ Everyone who arrives together also leaves together

When positions overlap this heavily, selling pressure has no natural buyer. Who do you sell to? Only to the same crowd that also wants out. So on days when the broad market fell three or four percent, this portfolio could fall two or three times as much. The drop is not pricing in worse fundamentals. It is pricing in a narrow exit.

The chart holds one more number worth reading alongside it. In April this year the same portfolio gained 9.8% in a single month. Round trip, most of the excess return built up over the past year and a half has been handed back. This looks more like crowding moving in and out than a one-way collapse.

The line uses one investment bank's own construction. A different provider or weighting gives a different figure, but not a different story about crowding.

Source: Global equity strategy and quantitative research at an investment bank (Image: @BlakeMillardCFA)