There is a common, fairly logical story about market efficiency: the more people look at a stock, the more efficiently it should be priced. Attention brings trading, and trading corrects mispricing. Therefore, highly watched stocks should be harder places to find anomalies. QED. (quod erat demonstrandum, for those without the benefit of a classical education.)

That story is partly right. Unfortunately, it is not always right in the same direction.

Kewei Hou, Roger Loh, Lin Peng, and Wei Xiong’s paper, A Tale of Two Anomalies: The Implications of Investor Attention for Price and Earnings Momentum, is useful because it shows that investor attention does not lead to a single effect. The authors study two famous anomalies: price momentum and earnings momentum. Both are momentum effects, but they behave very differently when attention changes. Stocks that attract more attention show stronger price momentum but weaker earnings momentum. Less attention does the opposite: weaker price momentum, stronger earnings momentum.

That is a great result because it breaks a lazy mental model. Attention is not simply a force for efficiency. Sometimes attention corrects underreaction. Sometimes it amplifies overreaction.

Start with earnings momentum. A company reports unexpectedly good earnings. In a perfectly efficient market, the price should immediately adjust to the new information. In reality, prices often drift in the direction of the earnings surprise for months. This is post-earnings-announcement drift, one of the most persistent anomalies in finance. The usual behavioral explanation is underreaction. Investors do not fully process the information at once, so the price moves gradually.

In this setting, attention should reduce the anomaly. If more investors are watching the stock, reading the earnings release, updating models, asking questions, and trading the news, the information should be incorporated faster. There is less room for a slow drift. That is what the paper finds: earnings momentum is weaker in high-attention stocks and stronger in low-attention stocks.

That part fits the standard intuition. Attention helps.

Price momentum is different. Price momentum is the tendency for stocks that have recently gone up to keep going up, and stocks that have recently gone down to keep going down. It is not tied to one discrete information event like an earnings announcement. It is more diffuse. It can arise from underreaction, but it can also arise from extrapolation, herding, feedback trading, institutional flows, and investors chasing winners.

In that setting, attention can make the anomaly stronger. A stock that is already going up attracts more eyes. The price move itself becomes part of the information set. Investors do not ask, “What is the company worth?” They ask, “Why is this going up, and will I look stupid if I miss it?”

This is how attention turns from a corrective force into an accelerant. The paper finds that price momentum profits are higher among high-attention stocks. In the older version of the study, the authors use trading volume and market state as attention proxies, finding stronger price momentum in high-volume stocks and up markets, while earnings momentum is stronger in low-volume stocks and down markets. They also report that price momentum reverses in the long run, while earnings momentum does not, which is consistent with price momentum having more of an overreaction component.

That distinction is the whole point. Earnings momentum is mainly about neglected information. Price momentum is often about attention feeding on itself.

For investors, this matters because “momentum” is too broad a concept to be captured by one word. There is not one momentum anomaly. There are different mechanisms that happen to produce continuation. One mechanism is delayed incorporation of news. Another is extrapolation from price action. Another is forced buying or selling. Another is career-risk-driven institutional behavior. Another is mechanical flow. The same return pattern can come from different causes.

This is why two strategies with similar backtest results can need opposite environments. Earnings drift wants neglect. It wants people to miss, ignore, or underweight information. Price momentum often wants visibility. It wants the crowd to notice the move and then chase, benchmark, explain, and justify it.

The practical implication is that attention can be used as a diagnostic. If you are trading post-earnings drift, you probably do not want the most watched stocks in the market. Apple and Nvidia do not get ignored. Everyone is watching. The event is modeled, previewed, live-blogged, and rehashed instantly. There may still be opportunities, but the simple underreaction story is less plausible.

If you are trading price momentum, the opposite may be true. A stock making new highs on high volume with increasing attention may have exactly the ingredients that create continuation. Not because the market is calmly and rationally converging on fair value, but because attention itself changes demand.

That does not mean high-attention price momentum is free money. The long-run reversal result is a warning. If price momentum is partly overreaction, then the trade is not just “buy strength.” It is “buy strength before the overreaction exhausts itself.” That is a very different problem. The edge may be real, but so is the crash risk when the story turns.

This is also a useful reminder for factor investors. A factor backtest often treats stocks as numbers that are isolated from the rest of the universe. But anomalies all depend on investor behavior. Who is watching the stock? Who can trade it? Who is forced to trade it? The same signal can mean different things in different attention regimes (refer to our earlier blog on conditional truth).

This is where the paper is most valuable. It does not just say investors are irrational. “Other people are stupid” is not a strategy. It says that attention changes the type of irrationality that matters. Inattention creates underreaction to information. Attention can create overreaction to price movement.

That is a much more useful behavioral finance lesson. Markets are not inefficient because investors are generically stupid. They are inefficient because different frictions and biases dominate in different settings. Sometimes the problem is that nobody is looking. Sometimes the problem is that everyone is looking.

As always, the one inviolable rule in investing is, “It depends”.

Disclaimer

This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the proposals and services described herein, any risks associated therewith and any related legal, tax, accounting, or other material considerations. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to their specific portfolio or situation, prospective investors are encouraged to contact HTAA or consult with the professional advisor of their choosing.

Except where otherwise indicated, the information contained in this article is based on matters as they exist as of the date of preparation of such material and not as of the date of distribution of any future date. Recipients should not rely on this material in making any future investment decision.