Career Risk – Herding – Momentum

Jeremy Grantham’s latest newsletter is out and as always is well worth the read. He is a value investor, but he comprehends the inherent structure of the stock market to a level, where he clearly understands why and how the momentum phenomena works. Institutional money managers manage first and foremost their career risk and then their clients’ risk, which results in very little originality on Wall Street and essentially herding. Herding is the foundation behind momentum. There is nothing wrong to be part of the herd as long as you have well thought out, disciplined exit strategy. Herding is not uniquely human. It can be noticed in almost all living species on Earth. It is ingrained in our brains as a basic approach for survival.

Remember, when it comes to the workings of the market, Keynes really got it. Career risk drives the institutional world. Basically, everyone behaves as if their job description is “keep it.” Keynes explains perfectly how to keep your job: never, ever be wrong on your own. You can be wrong in company; that’s okay.

Keynes had it right: “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.” So, what you have to do is look around and see what the other guy is doing and, if you want to be successful, just beat him to the draw. Be quicker and slicker. And if everyone is looking at everybody else to see what’s going on to minimize their career risk, then we are going to have herding. We are all going to surge in one direction, and then we are all going to surge in the other direction. We are going to generate substantial momentum, which is measurable in every financial asset class, and has been so forever. Sometimes the periodicity of the momentum shifts, but it’s always there.

Anatomy of a Monstrous Move

Only 9 trading days into 2011, there is a stock that is already up 150% ytd. – $BRN. I don’t know much about the company’s underlying business and my thoughts in this post will be focused purely on the technical characteristics of the move.

Shares outstanding = 8.3mm
Float = 4.5mm
Current market cap = $74mm

There is a high negative correlation between the size of the float and the potential for a big move up or down as the smaller the float, the tighter the potential supply and demand. The smaller the market cap, the more volatile one stock could be.

1) A high volume (in relative terms) 5%+ move above a long-term range. Average daily volume = 8k (no one pays attention as the stock is considered illiquid):

2) Consolidation

3) A Humongous Breakout (the stock finally appears on the radar of some traders, but at this point it looks overextended; therefore it is ignored)

4) Continues to slowly move up

5) Another monstrous range expansion (on a side note, here $BRN was featured in the daily TKO email as the best performing stock ytd)

6) The move up continues. For how long, it is anyone’s guess.