People who love positioning will make some argument about overlapping holdings across firms, leverage, crowding, unwind risk, squeezes etc and I’m sure that’s part of the answer, but there’s a simpler and better one.
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Short thread about momentum as a risk factor and why you should take it seriously. At first glance it sounds stupid — why would stocks that recently went up continue to move together in the future?
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Stocks that went up (or down) a lot recently probably did so because they are all part of the same “theme”. Could be a sector but it doesn’t have to be — it could be something like ‘reflation’ or ‘reopening’ or ‘EVs’ or ‘China’.
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The quant view is that they share common factor exposures. The cool thing is that you don’t need to know what the factor exposures are— one way to view the momentum factor is as an integral over all other factor exposures, weighted by factor volatility.
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That is, more volatile (= relatively more important) factors will move stock prices more, so the momentum factor will load up on them, in proportion to how important they are.
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It’s common to neutralise momentum to other factors (eg sectors, countries, size etc). In the limit where you neutralize to all known factors, momentum is a summary of exposure to all the *unknown* factors, the stuff you didn’t model because you didn’t know about it.
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That’s why you should include momentum in your risk model even if you don’t plan to use it as a source of alpha — it’s a simple, robust way of modelling the risks that you aren’t smart enough to think of in advance.
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