Revisiting the Reversal of Large Stock-Price Declines

Abstract

The impact of bid/ask spreads on price reversal is of significant interest and deserves further study. Prior to June 24th 1997 minimum bid/ask spreads were $0.125. After June 1997, the minimum was reduced to $0.0625 followed by a further decrease to the current $0.01 minimum on January 29, 2001. The impact of these reductions on the price reversal phenomenon is however, uncertain. This study evaluates both short- and long-term price reversals with stock prices examined over seven different time periods: one, three, seven, 30, 90, 180 and 360 trading days after the original price decline using data over the period 1997-2001. Results show that buying the 20 worst performing stocks and selling them one day later achieves significantly positive market adjusted annual returns on the NYSE and the NASDAQ. Results also show that during bull markets the price reversal strategy achieves positive adjusted returns on both NYSE and NASDAQ stocks for holding periods up to 7 days. Results during the years when the minimum bid/ask spread declined to $0.01 did not reduce returns from the price reversal investing strategy.

TOPICS: Technical analysis, performance measurement