The short-term contrarian strategy of buying stocks, which are past losers and selling stocks, which are past winners, is well documented in the academic literature. But does this effect work within different markets and with different instruments?
Recent research shows that short term reversal works not only in the equity market, but it is also applicable to futures. Research also suggests that trading volume contains information about future market movements. This “forecastability” can be enhanced with open interest as it provides an additional measure of trading activity. Therefore this contrarian strategy is most profitable if it is implemented on high-volume low-open interest contracts.
Evidence of short-horizon return predictability is consistent with the overreaction hypothesis; namely, traders over-adjust their posterior beliefs to news more than it is warranted by fundamentals. Overconfidence and overreaction themselves imply a large volume of trading and they are thus positively related to the magnitude of price reversals. Therefore an irrationality-induced market inefficiency gives rise to a negative relation between volume and expected returns. Open interest represents uninformed trading by hedgers or hedging activity and thus is also an important determinant of the market state.
bonds, commodities, currencies, equities
Confidence in anomaly's validity
Backtest period from source paper
Notes to Confidence in Anomaly's Validity
Period of Rebalancing
Notes to Indicative Performance
per annum, calculated as annualized (arithmetically) weekly returns (0.57%) for long short portfolio from table 5, weekly return to the contrarian portfolio is obtained by dividing the total profits by total long or short investment
Notes to Period of Rebalancing
Number of Traded Instruments
Notes to Estimated Volatility
estimated from t-statistic
Notes to Number of Traded Instruments
number of opened futures contracts with different backing
Notes to Maximum drawdown
Notes to Complexity Evaluation
Simple trading strategy
The investment universe consists of 24 types of US futures contracts (4 currencies, 5 financials, 8 agricultural, 7 commodities). A weekly time frame is used – a Wednesday- Wednesday interval. The contract closest to expiration is used, except within the delivery month, in which the second-nearest contract is used. Rolling into the second nearest contract is done at the beginning of the delivery month.
The contract is defined as the high- (low-) volume contract if the contract’s volume changes between period from t-1 to t and period from t-2 to t-1 is above (below) the median volume change of all contracts (weekly trading volume is detrended by dividing the trading volume by its sample mean to make the volume measure comparable across markets).
All contracts are also assigned to either high-open interest (top 50% of changes in open interest) or low-open interest groups (bottom 50% of changes in open interest) based on lagged changes in open interest between the period from t-1 to t and period from t-2 to t-1. The investor goes long (short) on futures from the high-volume, low-open interest group with the lowest (greatest) returns in the previous week. The weight of each contract is proportional to the difference between the return of the contract over the past one week and the equal-weighted average of returns on the N (number of contracts in a group) contracts during that period.
Wang, Yu: Trading activity and price reversals in futures markets
We use the standard contrarian portfolio approach to examine short-horizon return predictability in 24 US futures markets. We find strong evidence of weekly return reversals, similar to the findings from equity market studies. When interacting between past returns and lagged changes in trading activity (volume and/or open interest), we find that the profits to contrarian portfolio strategies are, on average, positively associated with lagged changes in trading volume, but negatively related to lagged changes in open interest. We also show that futures return predictability is more pronounced if interacting between past returns and lagged changes in both volume and open interest. Our results suggest that futures market overreaction exists, and both past prices and trading activity contain useful information about future market movements. These findings have implications for futures market efficiency and are useful for futures market participants, particularly commodity pool operators.
Strategy's implementation in QuantConnect's framework (chart+statistics+code)