Momentum, leveraged trading keep software stocks on roller coaster

Software shares in the U.S. are navigating a turbulent period, characterized by wild swings that investors anticipate will continue. This volatility stems from a combination of uncertainty surrounding artificial intelligence and the increasing influence of trading strategies that amplify market movements.

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These rallies, they start because there is an impending fundamental improvement that the market participants sniff out, but then they continue to build on themselves with momentum.

The S&P 500 software and services index exemplifies this trend, having lost over 33% of its value from a record high in October to a low in April. The index has since recovered some ground, but remains down more than 3% for the year and significantly below its previous peak. This rollercoaster ride is attributed partly to concerns that new AI developments could render existing software products obsolete, as well as the impact of momentum trading and leveraged funds.

Strategies like momentum trading, which involves buying rising stocks and selling falling ones, alongside leveraged funds that magnify daily price changes, are accentuating the sector's swings. For instance, Microsoft Corp. saw a significant surge following its earnings release. However, analysts like Tony Welch of SignatureFD note that it's difficult to determine how much of the recent gains are driven by fundamental improvements versus speculative bets on continued price momentum.

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as you get later into a move it does tend to be more of a momentum driver.

Further insights into the sector's health are expected from upcoming quarterly reports by Salesforce and CrowdStrike, followed by Oracle. The proliferation of leveraged exchange-traded funds (ETFs), particularly those focused on single stocks, has also surged, with a notable number targeting software companies. These products, offering amplified daily returns or losses, contribute to the heightened volatility observed in the software stock market.

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decent earnings and momentum trading, Joe Saluzzi, co-founder and head of equity market structure research and co-head of equity trading at Themis Trading, pointed to "derivative-style products like the double-leveraged ETFs and the single-day options."