Momentum and Reversion
Posted: 22 Aug 2015 Last revised: 27 Jun 2017
Date Written: August 20, 2015
Momentum and Reversion have always been seen as independent of each other and never as a composite. This study explains how the two behaviors are not only connected but also get transformed into each other. This dynamics drives not only stock market systems but all natural systems. One reason researchers did not see this composite behavior is because of the focus on independent components (asset prices) rather than a group of components (a collection of stock prices) and because of a lack of adequate framework to illustrate the two key behaviors together. Based on the author’s previous work on the ‘Mean Reversion Framework’, which explains how natural systems witness reversion and divergence simultaneously across different periods of time, this paper re-examines the framework for absolute trends. The trends are defined as the percentage number of components that transform themselves out of their original framework classification as Value, Core or Growth. All the three bins exhibit a consistency in transformation over time. More than 70% of all the components in the three bins transform out of their original position to other states. The absolute trends confirm that the Framework is not only a good proxy for understanding group behavior, but is also the reason why momentum gets transformed into reversion and vice versa. This opens up a new approach to construct investment portfolios, as a combination of momentum and reversion extends to a combination of trend - counter trend, fundamental value - growth, low-high beta, small-big size, low-high book value and various other styles.
Keywords: Momentum, Reversion. Framework
JEL Classification: A00, A10
Suggested Citation: Suggested Citation