In this paper, we propose a trend factor to capture cross-section stock price trends. In contrast to the popular momentum factor constructed by sorting stocks based on a single criterion of past year performance, we form our trend factor with a cross-section regression approach that makes use of multiple trend indicators containing daily, weekly, monthly and yearly information. We find that the average return on the trend factor is 1.61% per month, more than twice of the momentum factor. The Sharpe ratio is more than twice too. Moreover, during the recent financial crisis, the trend factor earns 1.65% per month while the momentum factor loses 1.33% per month. The trend factor return is robust to a variety of control variables including size, prior month return, book-to-market, idiosyncratic volatility, liquidity, etc., and is greater under greater information uncertainty. In addition, the trend factor explains well the cross-section decile portfolio returns sorted by short-term reversal, momentum, and long-term reversal as well as various price ratios (e.g. E/P), and performs much better than the momentum factor.
The basic idea is to first calculate the month-end price moving average time series of different lags, then regress cross-sectionally monthly returns at date t on all moving average series at date t-1, finally predict monthly returns at date t+1 using the regression estimates and the moving average series at date t. This procedure guarantees we forecast stock returns at t+1 with information set only up to t. We then rank all stocks based on the forecasts into five quintiles, long the quintile with highest forecast returns and short the quintile with lowest, and rebalance once per month. This strategy generates, on average, 1.61% monthly return and 0.29 sharpe ratio using all US stocks, performs especially good during recession, and outperforms several existing factors. Moreover, the good performance of this strategy cannot be explained by firm fundamentals.
I implement this strategy with Chinese stock data, adjust the rebalance frequency to weekly for convenience, and trade in extreme by always long the one stock with the highest forecast return, no short is allowed, stop loss is set at 5%. The result is amazing, it yields an annualized return at 97.15% from March, 2013 to Feb, 2014, with maximum drawdown at 30.01%. The fund curve is as follows (note: I didn't use all Chinese stocks but only 840 stocks in my stock pool with good liquidity, so there is selection bias and please accept the result cautiously...)
Nice shot. It seems to be better than the simple strategy between A-shares and H-shares.
Tags - trend , strategy , china
Read the full post at Performance of Trend Factor in Chinese market.