On the Design of Profitable Index Based on the Mechanism of Random Tradings

Abstract

Designing profitable trading strategies is an issue of interest to many experts and scholars. There are thousands of strategies in financial markets, and almost all of them can be divided into two types: momentum-type and contrarian-type. However, there is no formal way to determine which type of strategies are suitable for each stock. This study proposes a method to quantify and classify the momentum-type and the contrarian-type stocks for investors, which makes the trading strategies more quantitative. Our approach uses the technique of random trading and the proposed profitable index to quantify the stock attributes. We take the constituted stocks of Taiwan’s 50 (TW50) as research objects. According to the experimental results, there are 8 stocks in TW50 that are suitable for contrarian-type trading strategies, and the others 42 stocks are suitable for momentum-type trading strategies. We also use simple momentum and contrarian strategies to evaluate the effectiveness of the proposed algorithms and index. The results show the positive correlation between the momentum-type (contrarian-type) profitable index and the trading performance, and the correlation coefficient achieves 77.3% (80.3%). In conclusion, the scale of momentum-type and contrarian-type profitability index actually represents the profitability and the attribute of the stock.