“If investors overreact to new information, and if that overreaction is consistent, then it may be possible to construct trading strategies to benefit from this behavior,“ Dr. Victor Chow, Senior Investment Consultant at Vesper Capital Management, said in a note.
Investors tend to overreact to negative stock news driving the stock price down disproportionally and temporarily. For example, getting called down to Washington DC to testify to a Grand Jury, unplanned succession news, sexual harassment claims against a “C” suite executive and product recalls or a Twitter “tweet” storm involving the company may trigger short-term price declines.
However, not all companies in a sector are equal as some others may suffer collateral damage. There are likely to be several companies within a sector with better fundamentals that still look attractive.
Chow’s Ratio is a proprietary algorithm that utilizes short-term pricing data and volatility measures to screen for stocks that experienced one-week price declines and assesses their price stability to single out stocks that are fundamentally sound and have the greatest potential to experience a reversal, along with those that are fundamentally flawed and have the greatest potential for further decline.
“UTRN ranks stocks in the S&P 500 based on the Chow Ratio, choosing 25 stocks with the most attractive (lowest) chow ratio score for inclusion in the index each week. A stock is only removed from the portfolio on rebalancing if another stock has a lower value,” Thompson said.
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