Abstract
Momentum and reversal effects are important phenomena in stock markets. In academia, relevant studies have been conducted for years. Researchers have attempted to analyze these phenomena using statistical methods and to give some plausible explanations. However, those explanations are sometimes unconvincing. Furthermore, it is very difficult to transfer the findings of these studies to real-world investment trading strategies due to the lack of predictive ability. This paper represents the first attempt to adopt machine learning techniques for investigating the momentum and reversal effects occurring in any stock market. In the study, various machine learning techniques, including the Decision Tree (DT), Support Vector Machine (SVM), Multilayer Perceptron Neural Network (MLP), and Long Short-Term Memory Neural Network (LSTM) were explored and compared carefully. Several models built on these machine learning approaches were used to predict the momentum or reversal effect on the stock market of mainland China, thus allowing investors to build corresponding trading strategies. The experimental results demonstrated that these machine learning approaches, especially the SVM, are beneficial for capturing the relevant momentum and reversal effects, and possibly building profitable trading strategies. Moreover, we propose the corresponding trading strategies in terms of market states to acquire the best investment returns.
Highlights
IntroductionMomentum and reversal effects are common and interesting phenomena in stock markets
Momentum and reversal effects are common and interesting phenomena in stock markets.The momentum effect means that the stocks that have performed well, i.e., given higher returns, in the past will probably continue to outperform those that have performed poorly in the past in the future
The purpose of this paper is to propose the use of machine learning approaches instead of the traditional statistical methods that have been used in previous studies to investigate the momentum and reversal effects on the stock market
Summary
Momentum and reversal effects are common and interesting phenomena in stock markets. The momentum effect means that the stocks that have performed well, i.e., given higher returns, in the past (winners) will probably continue to outperform those that have performed poorly in the past (losers) in the future. The reversal effect was first observed by [1], in which it was found that buying losers and selling winners might acquire superior returns on the US stock market, because the US market overreacts to some events, which results in abnormal price movements. The momentum effect, which claims that buying winners and selling losers at the same time could earn significant positive returns over holding periods of 3–12 months on the US stock market, was discovered by [2]. Reference [4] found evidence of a substantial momentum effect in the China
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