Market Timing with the Backward SADF Test

Abstract

In this article, we explore the possibility of acquiring positive returns from the stock market during bubble periods. A structural break test is used to detect bubbles, and a technical statistic is applied to decide the direction of the bet. Unlike most of the previous articles on trading strategies, we present the out-of-sample return distributions of the strategy with respect to different trading rules based on three stock data sets, which helps investors understand the profitability and risk of the method. The result shows that our strategy is highly robust across different data sets, as it can acquire positive returns for more than 95% of the cases, with the highest annualized averaged return per trade at more than 36%. Additionally, the win rates are significantly above 0.5 for more than 95% of the cases. TOPICS:Quantitative methods, Statistical methods, Simulations Key Findings • The backward SADF test was designed to detect recently formed exponential patterns in time series. • The proposed strategy applies the backward SADF test and MACD statistics to exploit the statistical arbitrage from the exponential patterns. • We validate the strategy by comparing it with the buy-and-hold and daily-rebalance strategies and by running the Hendrickson–Merton based on three different data sets.