For years, the "momentum trade"—buying rising stocks and shorting falling ones—has delivered consistent gains. In the first half of this year, the strategy shined especially bright, with investors piling into AI darlings like Micron Technology, Nvidia, and Advanced Micro Devices while simultaneously shorting companies that could be rendered obsolete by the AI wave. The S&P 500 Momentum Index surged 44% in the second quarter, its best quarterly performance on record, and has climbed 133% over the past five years—nearly double the broader market's return.

Now, Wall Street's hottest strategy has suddenly hit a wall.

A Sharp Reversal: The Worst Quarter in 25 Years

Since July 1, the S&P 500 Momentum Index has tumbled more than 9%, while the broader S&P 500 has risen 2.8% over the same period. The index is on pace for its biggest quarterly underperformance relative to the broader market in a quarter-century.

According to Bank of America estimates, July was the second-worst month for momentum trading in nearly four decades—only April 2009, when the global financial crisis was at its peak, was worse.

Goldman Sachs data shows that in July, the basket of hedge funds' most heavily held stocks posted its largest monthly underperformance versus the S&P 500 in more than 20 years.

Goldman Sachs also told clients that August 19 was the worst single day for "systematic long-short managers" in over two years, with roughly half of the losses attributed to momentum trades.

Why Momentum Trading Used to Work

The logic behind momentum trading isn't complicated: assets with strong upward momentum tend to keep outperforming, while weak performers often continue to lag.

Agustin Lebron, senior researcher at trading firm EquiLibre, explained: "For decades, running a momentum strategy didn't require much complexity to generate decent returns." He noted that one reason is the time it takes for information to spread: "A large pension fund can't turn its positions around in a single day. There's also a behavioral bias—people tend to sell winners too early while holding onto losers too long."

Matthew Tym, managing director at Cantor Fitzgerald, called the strategy a "self-fulfilling prophecy"—the more people chase rising stocks, the stronger the rally becomes, which in turn attracts more participants.

Moderna's Surge Becomes the Trigger for the Unwind

One of the catalysts for this reversal was an unexpected rally in biotech stocks. Positive news on a cancer vaccine developed jointly by Moderna and Merck sent Moderna shares up about 150% this month. These biotech names had been heavily shorted in recent years.

The forced covering of short positions dealt a heavy blow to a large number of quantitative funds and hedge funds.

Meanwhile, the meltdown of the "AI stock guru" hedge fund Situational Awareness added to the market turmoil—the fund had concentrated holdings in hot momentum names like chip stocks and found itself in trouble after the sharp market swings.

Speculators Begin Flipping to the Short Side

Some traders are now shorting the very stocks that previously fueled the momentum trade. Data from the Commodity Futures Trading Commission (CFTC) shows that speculative net short positions in Nasdaq 100 index futures have recently climbed to their highest levels in nearly two decades.

Mike Ogborne, founder of San Francisco-based Ogborne Capital Management, said he has grown more cautious on tech stocks and is holding a higher-than-usual cash allocation. He expressed unease about the relentless capital expenditures of tech giants: "It's a bit like Cinderella and the midnight bell. You don't know when midnight will strike," he said. "Nobody sends you a memo telling you when the capex cycle will end."

Believers Remain Unshaken

Still, some are sticking with the strategy. Antti Ilmanen, global co-head of the portfolio solutions group at AQR Capital Management, remarked: "Every strategy has periods of disappointment." Supporters of momentum trading also point out that the worst months for the strategy historically have tended to occur within longer-term outperformance cycles.

But for now, market uncertainty is quietly building—even as the broader index continues to climb, the currents beneath the surface have turned turbulent.