Momentum, Market Volatility, and Reversal

Momentum profits collapse and reversal occurs when preceding market volatility is relatively high. Based on these intertemporal patterns, we implement an investment strategy that switches from momentum to reversal when volatility is high. The proposed switching strategy has two advantages over scaled momentum strategies: (1) the leverage factor is constant, and (2) no ex-post information is used to control for volatility. In U.S. stock market tests across a variety of performance metrics, the switching strategy distinguishes itself from traditional and volatility scaled momentum strategies by eliminating losses due to momentum crashes. Further evidence confirms that the switching strategy is successful in other developed and emerging stock markets, especially in Japanese and Chinese stock markets