Other Types of Market Anomalies

There are a number of market anomalies that traders leverage for short term gains. Here are some of them:

For the past week, we have been reviewing what market anomalies are, how they can be leveraged, and the kinds that exist. Having reviewed the calendar effect market anomaly and the value effect market anomaly in previous posts, here are a few other market anomalies that traders have come to learn and exploit:

Short-Term Price Change

This market anomaly stems from the assumption that changes in share price ride in the same direction for a while at least. For example, where announcements are made about the share price of a company rising, it would continue to rise in the short to medium term.

You too might have witnessed sudden spikes in the prices of companies like this. This form of price change in the short term often happens because relevant information would most likely not be reflected in the stock's price immediately.

It also doesn’t need to be based on price increase; it can also be from other form of public announcements made by the company. The first challenge of this is that this relies on human behavior being consistent which is not so.

It also is not sustainable as it involves timing the market to know when the façade causing the high price, would clear.

The Momentum Effect

Following closely from the anomaly above, the momentum effect is an anomaly based on the assumption that winners keep winning. This assumption is one we can find in our everyday life dealings.

Those who have come by luck a number of times, would tell you that they keep being lucky. In the regard of the stock market, the idea is that winners have the opportunity to keep winning as they pick on momentum and would most likely keep outperforming the losers in the short to medium-term.

On the Yochaa heat map, you can easily see the stocks performing well and the ones performing poorly. The idea it that traders can go long on the winners and go short on the losers.

The Head Becomes The Tail (Reversal)

There is also the assumption that there is a reversal of roles over periods of time. The stocks doing well would become the under-performers and the stocks doing badly, would be the new winners. While this might sound like something off a children’s book, there is actually a lot of logic to it.

If a stock is doing well, it means its share price is increasing. This also means that it is becoming more expensive and less people would be willing to buy at the current high price. In fact, those who own it and are trying to make immediate gains, would most likely try to sell it to make their gains.

On the flip side, stocks that are under-performing or low (especially those with high growth potentials), would attract buyers who would want to buy at its current low price for a chance to sell high. This demand for the low stocks would drive the price up and make the stock begin to perform better.

Market anomalies are not so beneficial to investors interested in growth. They are tools that can only be exploited by traders and they too are risky because they are usually for the short term. A focus on growth is still key to building sustainable wealth.

Written by Lawretta Egba