The selection of popular trading strategies

Abstract

Purpose

The relative performance of five popular nonzero-investment strategies, including Size, book-to-market ratios, earnings-to-price (E/P) ratios, cash flow-to-price (CF/P) ratios and dividend-to-price ratios, and their corresponding zero-investment strategies (also known as premiums) are first examined altogether for equally weighted (EW) and value-weighted (VW) methods to check whether a certain strategy (or some strategies) could be recommended to portfolio managers as the best (better) strategy (strategies). The paper aims to discuss these issues.

Design/methodology/approach

This paper uses the stochastic dominance (SD) approach, a non-parametric test, to investigate the relative performance among various strategies and help investors search for the best or better strategy (strategies).

Findings

The main results show that both the highest E/P and CF/P strategies (and their corresponding premiums) generally produce higher returns than the other three strategies (and their corresponding premiums) through allocating investors’ capital between the risky and risk-free assets for the EW and VW methods, respectively.

Research limitations/implications

This study only examines US stock markets by SD approach, whether the results are consistent with non-US markets still needs further investigation. The findings imply that investors can benefit by investing in the highest E/P or CF/P stocks (or their corresponding premiums) to make more profit or less loss for US stock markets.

Practical implications

First, the SD findings suggest that investors or portfolio managers can allocate their funds between risky and risk-free assets to maximize their profits. Next, the simulation results again prove that the profits of each nonzero-investment or zero-investment strategy for EW portfolios are higher than those of each corresponding strategy for VW portfolios. Finally, the findings imply that portfolio managers or investors can invest in the highest E/P or CF/P stocks (or their corresponding premiums) to make more profit or less loss.

Originality/value

This study first uses an extensive data set (1952-2009) to examine the relative performance of nonzero-investment strategies and their corresponding zero-investment strategies for the five popular indicators altogether for the EW and VW methods with the SD approach for US stock markets. Moreover, the results reveal that the investors or portfolio managers can invest in the highest E/P and/or CF/P portfolios (or their corresponding premiums) to make more profit or less loss.

Citation

Chung, Y.-T., Liao, T.L. and Chiang, Y.-C. (2015), "The selection of popular trading strategies", Managerial Finance, Vol. 41 No. 6, pp. 563-581. https://doi.org/10.1108/MF-05-2014-0121