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Riskier the Better Is Rallying Cry of Day Traders Going Small

(Bloomberg) — A nondescript week for large-cap indexes belied manic action below the stock market’s surface, where individual investors swarmed to anything with the potential for big returns.

While the biggest benchmarks for U.S. equities fell, smaller and more speculative corners posted solid gains. Fueled by day traders, volume in penny stocks exploded, and bullish options saw the second-busiest day ever. The craze for initial public offerings forged ahead, with newly minted shares from Affirm Holdings Inc. and Poshmark Inc. doubling on their debut.

“When you have a risk-on mentality, what you’ll start seeing is very exuberant personalities coming out and doing things they wouldn’t normally do,” said Rob Conzo, chief executive officer of The Wealth Alliance. “People are believers in equities. They’ve seen their equity portfolios go through the roof.”

The organizing principle is size — the smaller a stock is, the better it did. While the S&P 500, Dow Jones Industrial Average and Nasdaq Composite each retreated about 1% over the week, an index tracking microcaps surged 3.3%.

In lightly regulated off-exchange venues that professional investors generally avoid, day traders are fueling a volume explosion. More than 1 trillion shares changed hands in December over systems run by firms like OTC Markets, and trading was similarly scorching this week.

Few stocks illustrate the insatiability of animal spirits better than Signal Advance Inc., a medical firm that soared as much as 885% on Monday after Elon Musk urged for his followers to “use Signal,” an unrelated messaging app. Or Zomedica Corp., a penny stock that almost doubled in one session after a Netflix star promoted the firm in a video.

“What you’re seeing more is the more trading-oriented retail investors that follow short-term trends,” said Dan Miller, director of equities at GW&K Investment Management. “When it comes in in an indiscriminate way, it drives up the less liquid, more speculative names.”

Growing interest in the exotic areas of the market reflects trends in risk taking in general. Broadly, small stocks are winning over large ones, volatile stocks are trouncing sleepy ones, and companies with shaky finances are ahead of those with strong balance sheets.

Even skeptical investors are showing signs of caving to the craze. Hedge funds, for instance, spent Wednesday trimming their bearish wagers, with short covering in technology and consumer-discretionary shares reaching a five-year high, data compiled by Goldman Sachs’s prime brokerage show. Their overall net leverage, a measure of industry risk appetite that takes into account long versus short positions, has increased to a record.

“You have a combination of the fiscal stimulus and continued monetary support — that’s a very powerful driver of capital markets,” said John Porter, head of equities at Mellon Investments. “It’s hard to bet against that kind of flow of money.”

The exuberance contrasts with 2020, when technology giants such as Apple Inc. dominated the market as investors sought safety in the stay-at-home trade amid the pandemic outbreak. For bulls, the broad stock participation is healthy. But to plenty of Wall Street hands, it sows anxiety.

“You’re seeing some unbelievable momentum on the retail front, traders are chasing volumes more than doing active stock picking, and smaller companies with low price tags is where they go,” said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group. “When you see outlier moves like the ones we saw this week, that’s not rational, and that’s where I start to get concerned.”

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