The rapid collapse of momentum trading is now inflicting severe damage on its most loyal followers: retail investors.
The stock basket tracking retail investors' favorite holdings posted its worst monthly decline since 2022. Jefferies' Russell 1000 High Retail Participation Basket has fallen over 25% since June.
Among the 11 quantitative factors tracked by Bloomberg, the momentum factor ranked as the worst performer in July, becoming the most deeply wounded strategy during the current market adjustment. The characteristic "YOLO" (You Only Live Once) chasing behavior of retail investors has suffered a direct hit this month.
A confluence of bearish factors triggered the collapse of momentum trades: doubts about returns on massive AI investments prompted hedge funds to liquidate tech positions at a record pace, renewed tensions in Iran, and uncertainty over the Federal Reserve's interest rate path further dampened these already crowded trades. As a result, retail investor participation has notably cooled—Vanda Research data shows that weekly rolling net purchases of individual stocks have fallen to their lowest levels since the COVID-19 pandemic.
Momentum Factor Sees Biggest Four-Year Drawdown, Retail Investors Hit Hardest
This month's rout in momentum trades has dealt a particularly direct blow to retail investors.
Stocks heavily held by retail investors, such as Robinhood Markets and Marvell Technology, are among those affected. The relevant basket has posted its worst monthly decline since 2022.
Viraj Patel, a global macro strategist at Vanda Research, noted, "Semiconductor and AI hardware stocks have been the core drivers of the momentum strategy, and these names have long been staples in retail portfolios." This highly concentrated holding structure is why the momentum factor's drawdown has been far more damaging to retail investors than to other groups.
Multiple Headwinds Converge to Accelerate the Unwinding of Crowded Trades
This collapse of momentum trades is not the result of a single factor.
According to Bloomberg, concerns about the prospects for returns on AI investments first triggered hedge funds to cut tech positions at a record pace. Subsequently, renewed tensions in Iran and market anxiety over the Fed's rate path further eroded investor confidence in these already highly crowded trades.
At the sector level, tech-focused ETFs have experienced massive capital outflows.
Retail Participation Drops to Pandemic Lows, But No Full Retreat Yet
Retail market activity has contracted noticeably during this shock.
Vanda Research data shows that weekly rolling net purchases of individual stocks have fallen to their lowest levels since the COVID-19 pandemic. Meanwhile, JPMorgan Securities data indicates that total retail fund inflows for the week through Wednesday were $5.7 billion, below the 12-month weekly average of $6.8 billion.
Arun Jain of JPMorgan wrote in a report, "The slowdown in retail participation is highly consistent with the recent market anxiety surrounding the momentum drawdown."
However, JPMorgan data also shows that retail investors are not entirely fleeing the market; instead, they have become more selective.
Microsoft and Nvidia continue to attract significant net buying, while Apple and Tesla have experienced the greatest selling pressure. Patel stated, "Retail fund flows are becoming very dispersed. Unlike last year's 'buy everything AI' logic, retail investors are now being very cautious in their stock selection."
Wall Street Advises Buying the Dip, Momentum Factor Shows Strong Rebound Signals
The rapid decline has prompted multiple trading desks on Wall Street to advise clients to buy the dip.
Michael Romano of UBS Securities wrote in a client note, stating that this selling wave may have already eliminated most of the speculative froth, potentially laying the groundwork for a price bottom. Bank of America's trading desk urged clients to buy US momentum stocks, arguing that after a period of profit-taking, the sector has entered an attractive entry point.
Based on recent data, rebound signals are already emerging. Bank of America's US momentum stock basket has risen 8.9% over the past three trading days, its biggest three-day gain since November 2024. UBS's momentum indicator surged 11%, marking its largest three-day gain since 2022.
Patel commented, "Momentum trading—and retail investors—have experienced a rollercoaster ride. But once the selling pressure subsides and the buyer strike ends, the conditions for a meaningful rebound will become increasingly favorable."
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