Improving Price Reversal Strategies With ‘Residual Reversals’

Price reversal strategies, which buy stocks that have recently outperformed and short stocks that have recently underperformed, aren’t supposed to work. In an efficient market, prices reflect all available information and any investment based strictly on past performance shouldn’t be able to consistently outperform the market. But price reversal strategies do outperform, whether this is because they take advantage of investors’ non-rational tendency to overreact to new information or because price reversal strategies are getting a premium for supplying liquidity is an academic debate.

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The more important issue is whether price reversal strategies, which involve rebalancing your portfolio monthly or even more often, can be improved to the point that they...