Why do markets sometimes behave irrationally, even in today’s data-driven systems?
The momentum effect—where rising asset prices tend to rise further and falling prices continue to drop—remains one of the most significant market anomalies. First identified by Jegadeesh and Titman (1993) in their seminal 1993 paper titled “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.”, momentum strategies consistently deliver profits, challenging the Efficient Market Hypothesis (EMH) and traditional models of market efficiency.
Key Behavioral Drivers of Momentum
1️⃣ Overreaction Bias:
Investors overreact to positive signals due to overconfidence, inflating valuations beyond fundamentals.
Example: The tech boom during the pandemic led to overvalued stocks and subsequent corrections in 2022-2023.
2️⃣ Underreaction Bias:
Conservatism bias slows investor responses to new information, delaying price adjustments.
Example: Green energy stocks often react sluggishly to regulatory or technological breakthroughs, creating momentum opportunities.
3️⃣ Disposition Effect:
Investors sell winners too early and hold onto losers, distorting price movements.
Example: Meme stock trading, like GameStop and AMC, exhibited exaggerated volatility as investors mishandled gains and losses.
Why It Matters in 2025
Despite advances in AI-driven trading and real-time market access, investor psychology remains a critical factor in market inefficiencies. Behavioral biases like herd mentality and survivorship bias, amplified by social media, shape market trends.
🌎 Emerging Markets:
Behavioral finance is especially relevant in emerging markets, where thin trading and stronger investor biases make momentum strategies particularly effective.
Fatehbir Singh Sohu 