The once invincible general has failed: the sudden collapse of momentum trading on Wall Street.

For years, "momentum trading," which involves buying rising stocks and shorting falling ones, has proven consistently successful. This strategy was particularly successful in the first half of this year—investors flocked to AI star stocks like Micron Technology, Nvidia, and AMD, while simultaneously shorting companies potentially eliminated by the AI wave. The S&P 500 Momentum Index surged 44% in the second quarter, marking its best quarterly performance ever, and its cumulative gain over the past five years reached 133%, almost double that of the broader market.

However, the hottest strategy on Wall Street suddenly changed course.

A sudden reversal: worst quarter in 25 years

According to a Wall Street Journal report on August 30, the S&P 500 Momentum Index has fallen by more than 9% since July 1, while the S&P 500 has risen by 2.8% over the same period. The index is facing its biggest quarterly underperformance in 25 years.

According to Bank of America's estimates, July was the second worst month for momentum trading in nearly 40 years—the only month worse was April 2009, when the global financial crisis was at its worst.

Goldman Sachs data shows that in July, the underperformance of hedge fund portfolios relative to the S&P 500 was the largest in over 20 years.

Goldman Sachs also informed clients that August 19 was the worst single day for "systematic long and short managers" in more than two years, with about half of the losses coming from automatic trading.

Why Momentum Trading Once Worked

The logic of momentum trading is not complicated: assets with strong upward momentum tend to continue to outperform, while assets with weak performance tend to continue to lag behind.

"For decades, running a momentum strategy hasn't required much complexity to generate decent returns," explains Agustin Lebron, a senior researcher at EquiLibre trading firm.

He further pointed out that one reason is the time required for information dissemination: "A large pension fund cannot reposition itself in a single day. Behavioral bias is also a factor—people tend to sell winners too early while holding onto losers."

Matthew Tym, managing director of Cantor Fitzgerald, calls this strategy a "self-fulfilling prophecy"—the more people chase the rally, the stronger it becomes, which in turn attracts even more people to enter the market.

Moderna's surge became the trigger that crushed momentum trading.

One of the triggers for this reversal was the unexpected surge in biotech stocks.

Positive news has emerged regarding the cancer vaccine jointly developed by Moderna and Merck, and Moderna's stock price has surged by approximately 150% so far this month. These biotech stocks are precisely the targets of heavy short selling in recent years.

Short sellers were forced to cover their positions, which directly dealt a heavy blow to a large number of quantitative funds and hedge funds.

Meanwhile, the collapse of Situational Awareness, the hedge fund of the "AI stock guru," exacerbated market turmoil—the fund, heavily invested in popular momentum stocks such as chip stocks, found itself in trouble after the market volatility.

Speculators began to short sell.

Some traders have begun shorting the stocks that previously drove momentum trading.

According to data from the U.S. Commodity Futures Trading Commission (CFTC), speculators' net short positions in Nasdaq 100 index futures have recently climbed to their highest level in nearly 20 years.

Mike Ogborne, founder of San Francisco-based Ogborne Capital Management, said he has become more cautious about tech stocks and is holding a higher percentage of cash than usual.

He expressed unease about the tech giants' ever-increasing capital expenditures: "It's a bit like Cinderella and the midnight bells. You don't know when midnight will come," he said. "Nobody's going to send you a memo telling you when the capital expenditure cycle is over."

The believers remain unwavering.

Nevertheless, some people still adhere to this strategy.

"Every strategy has its disappointing periods," said Antti Ilmanen, Global Co-Head of Portfolio Solutions at AQR Capital Management.

Proponents of momentum strategies also point out that historically, the worst months for momentum trading have often occurred during longer-term outperforming cycles.

However, market uncertainty is quietly rising – even though the market index is still climbing, undercurrents are already surging beneath the surface.

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