Option Trading Blog

A popular view held by behavioural economists and psychologist alike is that people overreact to information. De Bondt and Thaler, two researches, suggested because of this a strategy of buying past losers and selling past winners that will achieve abnormal returns. They showed that over 3 to 5 years holding periods, stocks that performed poorly over the previous 3 to 5 years achieve higher returns than stocks that performed well over the same period.

De Bondt and Thaler results are questioned and some explanations have been offered. Some of these include the size effect and the effect of systematic risk (on these and more i’ll write in later posts). In addition, the long-term losers outperform the long-term winners only in Januaries (what is known as the January Effect). Jegadeesh (1990) reported that a contrarian strategy (Buying Winners and Selling Losers), based on information from the previous month, yields statistically significant excess return of 1.99% per month over the 1934-1987 in the markets, and 1.75% outside January. Jegadeesh proposed explanation is lack of liquidity in the market rather than over-reaction.

If you are asking yourself why go back only one month and not one week back for instance, there is no good explanation in Jegadeesh’s paper. I am not sure there is a paper on other smaller intervals but I’m pretty sure people have tried it by themselves. It could be worth a try.

The strategy of buying losers and selling winners has been studies in most countries by now. It’s existence has implications on Efficient Market Hypothesis. I was interested to see if in the Israeli Stock Market, this strategy is worthwhile. You can see the paper here. My conclusion was that it did not work in the Israeli Stock Market. Maybe Buying Losers and Selling Winners? worth a try in my view for all of you out there. Unlike other big markets, the Israeli market is still full in my view with more statistical anomalies.