Trend Factor and Future Stock Returns
December 23, 2015 - Momentum Investing, Technical Trading
Does the information in short, intermediate and long stock price trends combined by relating multiple simple moving averages (SMA) to future returns usefully predict stock returns? In the September 2015 update of their paper entitled “A Trend Factor: Any Economic Gains from Using Information over Investment Horizons?”, Yufeng Han and Guofu Zhou examine a trend factor that simultaneously captures short, intermediate and long stock price trends. Specifically, at the end of each month for each sampled stock, they:
- Calculate SMAs over the past 3, 5, 10, 20, 50, 100, 200, 400, 600, 800 and 1,000 trading days.
- Normalize SMAs by dividing by the final close.
- Regress monthly SMAs against next-month stock returns to estimate historical linear coefficients for all SMAs.
- Predict the return for the stock next month based on average SMA coefficients for the past 12 months applied to the most recent set of SMAs.
They define the trend factor as the average monthly gross return for a portfolio that is each month long (short) the equally weighted fifth (quintile) of stocks with the highest (lowest) expected returns. Using daily prices and associated stock/firm characteristics for a broad sample of U.S. common stocks during January 1926 through December 2014, they find that: Keep Reading