A trend factor: Any economic gains from using information over investment horizons?

Abstract

In this paper, we provide a trend factor that captures simultaneously all three stock price trends: the short-, intermediate-, and long-term, by exploiting information in moving average prices of various time lengths whose predictive power is justified by a proposed general equilibrium model. It outperforms substantially the well-known short-term reversal, momentum, and long-term reversal factors, which are based on the three price trends separately, by more than doubling their Sharpe ratios. During the recent financial crisis, the trend factor earns 0.75% per month, while the market loses −2.03%<math><mrow is="true"><mo is="true">−</mo><mn is="true">2.03</mn><mo is="true">%</mo></mrow></math> per month, the short-term reversal factor loses −0.82%,<math><mrow is="true"><mo is="true">−</mo><mn is="true">0.82</mn><mo is="true">%</mo><mo is="true">,</mo></mrow></math> the momentum factor loses −3.88%,<math><mrow is="true"><mo is="true">−</mo><mn is="true">3.88</mn><mo is="true">%</mo><mo is="true">,</mo></mrow></math> and the long-term reversal factor barely gains 0.03%. The performance of the trend factor is robust to alternative formations and to a variety of control variables. From an asset pricing perspective, it also performs well in explaining cross-section stock returns.