Momentum, leveraged trading keep software stocks on roller coaster

Aug 26 (Reuters) - U.S. software shares have been on a roller coaster and more wild rides likely lie ahead, thanks to AI-driven uncertainty and the rise of trading strategies that investors say are accentuating the swings in popular technology sectors.

After hitting a record high on October 28, the ‌S&P 500 software and services index lost more than 33% of its value by April 10, with selling accelerating following a January product release by Anthropic that some ‌portfolio managers worried would make many of these firms' products obsolete.

The index then bounced 33% during a mostly solid first-quarter earnings season, before selling off again and then partly recovering once more during a largely healthy second-quarter earnings season. The ​index is down more than 3% for the year and is more than 12% below its October record. Software investors will tune in next for quarterly reports from Salesforce and CrowdStrike on Wednesday afternoon, followed by Oracle in mid-September.

Even for an industry under threat from the rise of AI, the intense swings in software are testament to the power of popular strategies such as momentum trading, buying shares that are rising and selling those that are falling, and the rise of leveraged funds that can double or triple daily moves.

The latest sector bounce was highlighted by an eight-session, 29% surge in ‌shares of Microsoft Corp, the biggest stock in the index and one ⁠of the biggest in the world, following its July 29 earnings release.

While some of the latest quarter's results showed "eye-popping" strength, Tony Welch, chief investment officer at SignatureFD, said it remains unclear how much of the summer bounce stemmed from improving confidence in fundamentals -- and how much resulted from trader ⁠bets that the price momentum would continue.

"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," said Welch, adding that "as you get later into a move it does tend to be more of a momentum driver."

Along with "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."

The leveraged ETF segment, which includes single-stock and index products offering ‌their buyers up to double the daily return or decline of many of the market's most popular and volatile stocks or triple the daily gains in an index, has exploded in size in the last two years. The number of single-stock leveraged or inverse ETFs has surged to 486 from 28 at the end of 2023, according to data from Morningstar. About 40 of the ETFs are in the software-infrastructure category while 23 are related to software application companies.