Momentum, Reversion and Risk

We have spoken about reversion, or losers outperforming winners. This approach works. In their 1985 paper ‘Does the stock market overeact?”, DeBondt and Thaler explained the idea of mean reversion and how it leads to the Loser’s portfolio of 3 years outperforming the Winner’s portfolio of the same time. Findings of reversion in stock prices towards some fundamental values remain in literature for a decade. DeBondt and Thaler[1985] using overreaction showcased that a stock experiencing a poor performance over a 3-5 year of period subsequently tend to outperform that had previously performed relatively well. This implies that, on average, stocks which are ‘losers’ in terms of returns subsequently become ‘winners’ and vice versa. This is the reversion strategy.

In another paper written by Narasimhan Jagadeesh and Sheridan Titman in 1993 the authors illustrate returns to buying winners and selling losers. The conclusion of the paper states “Trading Strategies that buy past winners and sell past losers realize significant abnormal returns”. The paper studies the momentum strategy comprehensively but focuses on the behavioral aspect i.e. what investor behavior causes the superior returns to happen in the year following the portfolio formation data and then the returns dissipate within the following 2 years?

Both these papers are highly cited and are considered significant in Behavioral Finance. Thaler and Kahneman got the Nobel Prize in 2002 for their work. However despite such path breaking work application of the work is limited. Were the Behavioral Finance practitioners more concerned about the behavioral aspects in the investment business than about investment strategies? Is this the reason why we never had a study talking about this conflict? The conflict is that in markets it is profitable buying winners and selling losers and vice versa.

To read the complete article visit Business Standard.

Our Jiseki Time cycles are seasonal patterns of strength or weakness in assets. They are derived from percentile rankings from 1 to 100. The higher the percentile more the chance for an asset to weaken and worst the ranking, better the chance for the respective asset to outperform. 100 is top relative performance and 1 is worst performance. The idea is that performance is cyclical. A top performer will underperform in future and vice versa. A top relative performer is also the worst value pick and the top relative underperformer is the best value pick. Jiseki is another name for Performance cycles, time triads and time fractals. The signals are illustrated as a running portfolio and as Jiseki Indices. These signals can be used by fund managers for relative allocations, traders for leverage bets and high net worth clients for selective trades.

Jiseki Interpretation. Signals are interpreted as crossovers between various Jiseki Cycles. All three Jiseki cycles (Jiseki 1,2 and 3) depict different time frames. Example: An asset is ranked above 80 percentile and all the three Jiseki cycles are pointing lower, this suggests a running SHORT SIGNAL. Our Jiseki Indices use different kind of exits based on price and Jiseki Cycles. We have color coded the (Jiseki 1>Jiseki 2) SHORT zones with brown sandy (burlywood) and grey (Jiseki 1>Jiseki2) for LONG SIGNALS.

Coverage: CNX 100 components and all Indian Sector Indices.

Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.

 


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