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Half-Day Reversal
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What will happen to a stock during the night after it fell awfully during a market
session? Similarly, what will happen to a stock during the day if it fell awfully Quantpedia is The Encyclopedia
during the night and opened with a big price gap? Academic research suggests that of Quantitative Trading
there is a short-term price reversal after the sharp price decline. This outstanding
Strategies
financial research paper also shows that this behavior could be exploited profitably.
Several different versions of this simple idea are presented in the research paper
We’ve already analysed tens of thousands of
and they are tested on several equity universes (large, mid, small cap). We picked financial research papers and identified more
one version which probably has the easiest execution – the model strategy is than 400 attractive trading systems together
executed in the S&P 500 universe and would buy the worst performing shares from with hundreds of related academic papers.
the open-to-close period and will hold them until the next open. The strategy’s
performance could be improved by using a less liquid (and harder to execute)
Browse Strategies %
universe like small-cap stocks. Or it could be enhanced by simultaneously using (https://quantpedia.com/screener/)
both strategies’ versions – nightly holding period and daily holding period.
However, the strategy’s performance has to be closely monitored in the future as or find out more
profits slowly erode (but are still above-average). This eroding could probably be (https://quantpedia.com/strategies/half-day-
stopped by using a shorter holding period. reversal/)

Fundamental reason

Contrarian strategies benefit from the overreaction to an isolated event. This

overreaction results in a trend reversal and contrarian signs of return after the
event, as opposed to during the event itself. The existence of contrarian profits can
be partly explained by the overreaction hypothesis – the original extreme move is
caused by the investors’ overreaction to firm-specific news.
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academic papers
Strategy Ideas

Markets Traded equities Financial instruments stocks

Backtest period from source

Confidence in anomaly's validity Strong 2000-2010
paper

Notes to Confidence in
Indicative Performance 57.7%
Anomaly's Validity
 per annum, data from
Period of Rebalancing Intraday Notes to Indicative Performance appendix, table e/, first decile

Notes to Period of Rebalancing Estimated Volatility 17.7%

data from appendix, table e/

Number of Traded Instruments 50 Notes to Estimated Volatility

Notes to Number of Traded

Maximum Drawdown 0%
Instruments

not stated
Complexity Evaluation Complex strategy Notes to Maximum drawdown
Notes to Complexity Evaluation Sharpe Ratio 3.03

Keywords reversal (https://quantpedia.com/screener/?FilterKeywords=reversal)

stock picking (https://quantpedia.com/screener/?FilterKeywords=stock+picking)

Simple trading strategy

The investment universe consists of all stocks from the S&P 500 index. The strategy buys the N ( 50 stocks in first decile) worst performing
shares from the open-to-close period (decision period). These shares are bought when the market closes and they are held until the next
day’s market open. They are subsequently sold for the opening price. Shares are equally weighted in the portfolio.

Hedge for stocks during bear markets

Partially - Source research paper doesn’t offer insight into correlation structure of proposed trading strategy to equity market risk,
therefore we do not know if this strategy can be used as a hedge/diversification during time of market crisis. Equity reversal strategies are
usually type of “liquidity providing” strategies and as such they usually perform well during market crises. However, reversal strategies are
also naturally a “short volatility” strategies, their returns increase mainly in the weeks following large stock market market declines.
Traders must be catious during crisis during days with a high volatility as reversal strategies usually force traders to buy stocks which
performed especially bad (and to sell short stocks with an extremelly positive short term performance). This position is emotionally hard to
open and risk management of reversal strategies must be also very strict during these days. We recommend reading research paper by
Nagel: “Evaporating Liquidity” to gain insight into behaviour of reversal strategies during crises.

Source paper

Dunis, Laws, Rudy: Profitable Mean Reversion after Large Price Drops: A story of Day and Night in the S&P 500, 400 Mid Cap and
600 Small Cap Indices
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2272795 ( http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2272795)

- Abstract

The motivation for this paper is to show the usefulness of the information contained in the open-to-close (day) and close-to-open (night)
periods compared to the more frequently used close-to-close period. To show this we construct two versions of a contrarian strategy, where
the worst performing shares during the day (resp. night) are bought and held during the night (resp. day). We show that the strategies
presented here generate a significant alpha and their returns cannot be solely explained by the factors derived from Fama and French
(1993) 3-factor model and a modified 5-factor model introduced by Carhart (1997). Even after we account for the bid-ask bounce effect the
returns generated are significant and consistent. The information ratios of the two strategies mentioned for the entire period 2000-2010
vary between 1.59 and 6.70 depending on the capitalization of stocks. Overall, we show that opening prices contain information that is not
generally fully utilized yet. The strategy proposed uses this information to add value and extract a significant alpha which cannot be
explained by market factors

Strategy's implementation in QuantConnect's framework (chart+statistics+code)

Charts Statistics Code Clone Algorithm 0

(https://www.quantconnect.com)

106k

104k
Equity

102k

100k

98k

2016 2018 2020

Other papers

Ramiah, Mugwagwa, Naughton: Hot and Cold Strategies: Australian Evidence

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.485.7450&rep=rep1&type=pdf ( http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.485.7450&rep=rep1&type=pdf)

- Abstract
http://www.efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2008-athens/366.pdf

Abstract:

This study explores a high-frequency tactical asset allocation strategy. In particular, we investigate the profitability of momentum trading
strategies and contrarian investment strategies for equities listed on the Australian Stock Exchange (ASX). This paper takes into
consideration the short-selling restrictions imposed by the ASX on the stocks used in these two strategies. We look at the relationship
between stock returns and past trading volume for these equities within our sample portfolios. This research also investigates the seasonal
aspects of contrarian portfolios and observes an April effect. We report significant contrarian profits for the period investigated and show

that contrarian profit is a persistent feature for the strategies examined. We also document that contrarian portfolios earn returns as high
as 6.54% per day for portfolios with no short-selling restrictions, and 4.71% on the restricted model. The results also support the view that
volume traded affects stock returns and shows that market imperfections such as short-selling restrictions affect investors’ return.

Kudryavtsev: Overnight Stock Price Reversals

https://www.researchgate.net/profile/Andrey_Kudryavtsev/publication/269515222_Overnight_Stock_Price_Reversals/links/58fb252ca6fdccde98948caa/Overnight-Stock-Price-Reversals.pdf?

origin=publication_detail ( https://www.researchgate.net/profile/Andrey_Kudryavtsev/publication/269515222_Overnight_Stock_Price_Reversals/links/58fb252ca6fdccde98948caa/Overnight-

Stock-Price-Reversals.pdf?origin=publication_detail)

- Abstract
https://ideas.repec.org/a/rej/journl/v16y2013i50p51-64.html

http://www.degruyter.com/view/j/jasf.2012.3.issue-2/v10259-012-0011-1/v10259-012-0011-1.xml

Abstract:

In present study, I explore the dynamics of stock price reversals. In particular, I try to shed light on the overnight reversals, that is, on the
price reversals between the end of a trading day and the opening session of the next trading day. To account for the “end-of-the-day” price
moves, for each of the stocks currently making up the Dow Jones Industrial Index, I compare, on the daily basis, the high-to-close and the
low-to-close price changes, and also compare them to the same day’s average and median changes for the total sample of stocks. I
document that opening returns tend to be higher following the days with relatively large high-to-close price changes (price decreases at the
end of the day), and lower following the days with relatively large low-to-close price changes (price increases at the end of the day). Such
“overnight reversals” price behavior seems to contradict the market efficiency. Finally, I construct five portfolios based on the opening
trading sessions and involving a long position in the stocks on the days when, according to the “overnight reversals” behavior, their
opening returns are expected to be high and a short position in the stocks on the days when their opening returns are expected to be low.
All the portfolios are found to yield significantly positive returns, providing an evidence for the practical applicability of the “overnight
reversals” pattern in stock prices.

Kakushadze: 4-Factor Model for Overnight Returns

http://arxiv.org/pdf/1410.5513v2.pdf ( http://arxiv.org/pdf/1410.5513v2.pdf)

- Abstract
We propose a 4-factor model for overnight returns and give explicit definitions of our 4 factors. Long horizon fundamental factors such as
value and growth lack predictive power for overnight (or similar short horizon) returns and are not included. All 4 factors are constructed
based on intraday price and volume data and are analogous to size (price), volatility, momentum and liquidity (volume). Historical
regressions a la Fama and MacBeth (1973) suggest that our 4 factors have sizable serial t-statistic and appear to be relevant predictors for
overnight returns. We check this by using our 4-factor model in an explicit intraday mean-reversion alpha.

Abdi: Cycles of Declines and Reversals following Overnight Market Declines

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3287680 ( https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3287680)

- Abstract
This paper uncovers and explains the emergence of cycles of intraday declines and overnight reversals in the U.S. stock market in the 21st
century. Using quote midpoints for the past 24 years of common stocks traded in the three main exchanges, I show that the cross-sectional
association between average intraday and overnight returns has steadily shifted from a direct association into a strong inverse association
over the years. I explain this shift by showing that after 2001, consistent with theoretical models in which binding capital constraints lead
to liquidity dry-ups, an overnight decline in the stock market is followed by a further intraday decline for volatile stocks and their reversal
over the next overnight period. Moreover, I show that market liquidity of volatile stocks further deteriorates following an overnight market
decline, which confirms my proposed explanation. Finally, I show that idiosyncratic volatility, compared with systematic risk, better
explains the cross section of the documented systematic intraday declines and overnight reversals.

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