Sometimes simple is the best approach to generating returns. Forget complex models and just focus on the direction of markets. In the paper "Directional Information in Equity Returns", researchers shows that there is sign predictability in equity returns. Look at some sequence of equity returns and you will be able to capture investor optimism and pessimism which can tell us something about stock direction.
A set of stocks can be ranked based on the likelihood of direction to form a long-short portfolio. Buy the stocks that have a high likelihood of a positive move and sell those that have a high likelihood of a decline.
Just sorting by directional likelihood may be able to do a better job than a traditional momentum portfolio. In fact, over the period 1991-2022, a directional portfolio will don better than a traditional momentum sorted portfolio. Over the longer-term 1932-2022, these two portfolios will give similar results. Just focus on direction and the rest may take care of itself.
No comments:
Post a Comment