Momentum Origin and Investor Behaviors on Wall Street

Abstract

The Efficient Market Hypothesis (EMH) asserts that consistently outperforming the market is implausible because market prices promptly incorporate all available information. However, the momentum strategy has demonstrated consistent profitability, which poses a significant challenge to the EMH and suggests the presence of factors that extend beyond existing theoretical frameworks in influencing price movements. Here we present a model attributing changes in asset return to behavior interactions between liquidity takers and providers that directly impact price formation and discovery processes. The analysis of the measured behavior of liquidity takers and inferred market microstructure due to behaviors of liquidity providers generates signals relating to the forming, terminating, and reversal of price momentums. Applying these signals to the 1987 market crash yields warning flags about the looming crisis weeks before the sudden market plunge on Black Monday. As market crises always correspond with substantial negative price momentum, our model can serve to mitigate or avoid catastrophic investment losses during such events.