Trading Strategies  |  BON 2009

Reversals In Weekly Stock Returns by A. Tezel, PhD, and R. Sharma, PhD

Reversals In Weekly Stock Returns by A. Tezel, PhD, and R. Sharma, PhD Nasdaq stocks provide the highest net returns from a long strategy after a week of declining returns and declining highs and lows. Stock prices with strong momentum during the prior week or month tend to reverse in subsequent weeks. Strong positive (negative) momentum leads to overbought (oversold) conditions, implying a short-term drop (rise) in prices. Here you will see the relationship of weekly return reversal to weekly return consistency as well as to weekly high/low consistency. Stocks with positive (negative) return consistency have a high frequency of positive (negative) returns during a given period. Using return consistency for five days (that is, five days in a row the stock had a positive or negative return), we found a statistically significant effect of return consistency on subsequent reversals. However, net of transaction costs, only negatively consistent stocks led to profitable trades, and the Nasdaq stocks yielded returns above 30% a year. Typically, a rising market is considered healthy if prices make higher highs and higher lows. A percent retracement following higher highs and higher lows is an example of a short-term reversal. A five-day positive high/low consistency means that the stock has higher highs and higher lows in each of the five trading days. A five-day negative high/low consistency means that the stock has lower highs and lower lows in each of the five days. The results of high/low consistency are similar to those of return consistency. Our test results show that only negatively consistent high/low stocks yield profitable trades statistically. Nasdaq stocks earn the highest returns. DATA AND METHODS The data for stocks is from January 1983 to December 2005 and is obtained from Center for Research in Security Prices (Crsp) database from Wharton Research Data Services (Wrds). We identify a date as day zero if the stock has exhibited return consistency and/or high/low consistency. Return consistency exists for five days if for all five days the stock had a positive or negative return. Similarly, positive (negative) high/low consistency for five days exists if each day out of five days the stock had higher (lower) highs and higher (lower) lows.

by A. Tezel, PhD, and R. Sharma, PhD