This post has been authored by Priyanka Mulraj Jesrani, Financial Research and Analysis intern at Arthashastra Intelligence

The global coronavirus outbreak has left the youth and the economy in a turmoil. People are either unemployed or underemployed and are having to upskill or venture out and find new interests. This has seen a rise in retail investors trying to increase their savings. Maybe having little to no knowledge about risks of market investments but a drive to make money has led to an increase in momentum trading in stock market. Where investors are trading without understanding the risks undertaken, but on the market expectation of trending high prices.

Having said this, inflation and an uncertainty of time when things will go back to normal there has been a rise in momentum traders that are risk seeking who choose higher than average return instead of preserving capital. Griffin et al. (2003), has investigated the relationship between macroeconomic risk and momentum returns on a global level. They further find support for macroeconomic risks, which is the main driving force behind momentum profits. A popular type of investing that has seen a rise in interest is “Meme Investing” wherein stocks or bitcoin that are traded are due to the fact that they have large following on social media platforms such as Reddit or twitter.

Stocks that have been traded under this style have consistent high prices, fundamentals that don’t explain the price surge and have significant short interest. Retail traders could most likely profit from the rising share prices, but institutional investors or hedge funds may suffer if they have been short selling units of the stock. If a hedge fund has been betting that the price of a certain stock will decrease but all of a sudden, its share price starts to rise, this can cause them to have no choice but to cover their short position by buying the stock to avoid loss. Dogecoins are created as a reward for a process called mining for cryptocurrency but the real-world value for the coins are extremely volatile. Dogecoin, a cryptocurrency is based on popular ‘doge’ meme and features Shiba Inu on its logo created by Billy Markus and Jackson Palmer.

Dogecoin has no price-volume relation seen between the data over the last year. There can be an increase in volume or price without any direction. Calculating the VAR, with 99% confidence we can conclude that there is an increase of loss from almost 6.7% daily in 2019 to 38.1% daily in 2021. This increase in VAR and rise in Dogecoin volume would conclude that risk averse investors are not trading in cryptocurrency, and its only on speculation.

GME stock prices have been consistently rising over the last year without any change in the underlying profitability, liquidity or solvency ratios. GME stock price and volume has seen no correlation over the last year. It has been a target for significant short interest for hedge funds. Calculating the VAR with 99% confidence we can conclude the loss has increased from about 11.68% daily in 2019 to 46.97% daily in 2021. This increase in VAR and no change in fundamentals would conclude that risk averse investors are not trading in GME stocks and its only on speculation.

These momentum trades on speculation can create a rise in price where people assume other people trading on a specific stock have the knowledge about the risk and returns. This price bubble due to momentum investing can create unstable markets. This could be explained by behavioural finance to understand investor psychology. It could be explained by cognitive errors of Illusion of control bias. It exists when market participants think they have control on or can affect outcomes when they cannot. It could be associated with emotional biases of over confidence, illusion of knowledge and self-attribution. The over -confidence bias is where there is an unwarranted belief that you are correct without having any proof. The illusion of knowledge would be belief in knowing things that you do not know. Self-attribution would mean the satisfaction a person would get by the belief that you personally have caused something to happen.

With the rise in uncertainty in time when things would get back to normal, the increase in trying to have this illusion of control and FOMO could be driving reasons for increase in meme investing. Is it going to be as popular type of investing in the long run, only future would tell.

References

• Griffin, J.M., Ji, S. and Martin, J.S. (2001). Momentum Investing and Business Cycle Risk: Evidence from Pole to Pole. SSRN Electronic Journal.
• https://blog.mywallst.com/what-is-a-meme-stock/
• https://www.cnbc.com/2021/06/09/dogecoin-meme-stocks-why-boring-investments-are-still-the-best-bet.html
• https://www.vox.com/recode/22452151/memes-bitcoin-dogecoin-elon-musk
• https://www.moneycontrol.com/news/business/cryptocurrency/dogecoin-everything-you-need-to-know-about-the-meme-that-has-taken-the-crypto-world-by-storm-6883341.html
• https://www.forbes.com/advisor/investing/what-is-dogecoin/
• https://phys.org/news/2015-03-illusion-linked-higher.html
• https://markets.businessinsider.com/news/stocks/momentum-meme-stocks-how-to-find-the-next-top-reddit-stock-of-2021-1030290452