Crowded Trades, Short Covering, and Momentum Crashes

40 Pages Posted: 4 Mar 2014

See all articles by Philip Yan

Philip Yan

Quantitative Investment Strategies, Goldman Sachs Asset Management

Date Written: November 1, 2013

Abstract

Despite momentum's strong historical performance, its returns have large negative skewness and occasionally experiences persistent strings of sharp negative returns, referred as "momentum crashes" in the recent literature. I argue that momentum crashes are due to crowded trades which push prices away from fundamentals leading to strong reversals, and exacerbated by limits of arbitrage being more severe in the short-leg due to impediments to short selling. Using short interest and institutional ownership data together to measure the "crowdedness" of momentum, I show that momentum crashes can be avoided in the cross section by shorting only non-crowded losers. There is considerably more short-covering during times when momentum fails. I show using high frequency short sale transactions data that short covering is especially severe in the crowded loser portfolio. A placebo test using a set of 63 futures contracts show that momentum crashes do not exist in futures market after market exposure is correctly hedged, which is consistent with my hypothesis.

Keywords: momentum, momentum crashes, crowded trades, short covering, short squeeze

JEL Classification: G00, G10, G12, G14

Suggested Citation

Yan, Philip, Crowded Trades, Short Covering, and Momentum Crashes (November 1, 2013). Available at SSRN: https://ssrn.com/abstract=2404272 or http://dx.doi.org/10.2139/ssrn.2404272

Philip Yan (Contact Author)

Quantitative Investment Strategies, Goldman Sachs Asset Management ( email )

200 West Street
New York, NY 10282
United States

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