Advanced trading strategies based on the sobering-up effect

Abstract

PurposeThis study investigates analysts’ sobering-up effect on future stock returns and further verifies whether analysts’ familiarity with the forecasted firms and market sentiment affect the relationship between the magnitude of the sobering-up effect on analysts’ earnings forecasts and long-term future stock performance.Design/methodology/approachUsing stocks listed on the Taiwan Stock Exchange (TWSE) and the Taipei Exchange (TPEx) from 2000 to 2021, we propose a trading sobering-up strategy which involves taking a long position in the portfolio with a smaller magnitude of the sobering-up effect and a short position in the portfolio with a greater magnitude of the sobering-up effect.FindingsWe find that an advanced trading strategy which involves taking a long (short) position in the portfolio with a smaller (greater) magnitude of sobering-up effect during the bullish market period, is superior to the sobering-up trading strategy as well as the sobering-up plus familiarity trading strategy and can generate a significantly positive long-term abnormal stock return.Originality/valueThis study explores the dynamic psychological factors behind the magnitude of the sobering-up effect on analysts’ earnings forecasts’ influences. Employing familiarity and market sentiment verify the relationship between the magnitude of the sobering-up effect on analysts’ earnings forecasts and future stock returns. The results give a reference for investors when investing and offer the potential investors significant trading gains.