Buy High and Sell Low
Kevin Q. Wang
University of Toronto - Joseph L. Rotman School of Management
January 9, 2011
Motivated by range-related trading practices, this paper investigates the return-predictive role of relative price level. As the price of a stock moves to an unusually high or low level with respect to a long-term trading range, concern about mean-reversion in the price becomes important. I test this hypothesis using a mean-reversion-based measure to proxy for the relative price level. Tests show that the measure is a significant and robust predictor of cross-sectional variation in stock returns. The results suggest that in the presence of uncertainty about duration of firm-specific shocks, deviation from a perceived range makes investors conservative, which creates abnormal performance of a "buy high and sell low'' portfolio strategy. The relative price level effect is not driven by small-cap stocks and it is not a manifestation of momentum, reversal, the 52-week high, and volatility effects.
Number of Pages in PDF File: 42
Keywords: Relative price level, mean-reversion, trading range, investor conservatism, underreaction, technical analysis
Date posted: March 26, 2008 ; Last revised: January 10, 2011