Reversing the Trend of Short-Term Reversal

Abstract

The classic short-term reversal effect has steadily weakened over time, to the point of now having vanished entirely in most regions. However, the strategy can be revived by countering its tendency to go against short-term momentum in industry and factor returns. Enhanced short-term reversal strategies show a higher return with lower risk and have remained effective over time, culminating in more than double the risk-adjusted performance. Implementation challenges can best be overcome by combining short-term reversal with other short-term alpha signals. Various features of the short-term reversal strategy indicate that the premium stems from temporary imbalances between supply and demand. Investors in the strategy therefore effectively act as liquidity providers, contributing to a more efficient functioning of capital markets.

Keywords: Asset pricing, short-term reversal, momentum, factor investing, market efficiency, liquidity

JEL Classification: G11, G12, G14