Exploiting Momentum While Avoiding Long-term Reversal

Is there a way to enhance momentum strategy performance by avoiding stocks about to enter post-momentum, long-term reversals? In the May 2011 version of their paper entitled “Momentum – Reversal Strategy”, Hsin-Yi Yu and Li-Wen Chen investigate momentum-reversal trading strategies that buy past winners and sell past losers while seeking to avoid stocks about to reverse. They devise two ways to measure the trend in past stock returns and thereby assess likelihood of return reversal. The comparison method compares geometric mean returns over the past 12 months and n<12 months, hypothesizing that both past winner and past loser stocks with accelerating momentum are more likely to reverse. The alternative convex-concave method graphs geometric mean returns over the past 1 to 12 months versus number of months, hypothesizing that a convex (concave) profile indicates a high (low) probability of reversal for past winners and low (high) probability of reversal for past losers. They test the effectiveness of these two trend measures via five alternative trading strategies that reform portfolios monthly based on different momentum-only and momentum-reversal criteria. Using monthly returns for all NYSE/AMEX and NASDAQ common stocks during 1965 through 2009 (22,421 stocks), they find that: (more…)