Trend Factor: A New Determinant of Cross-Section Stock Returns

In this paper, we propose a trend factor to capture cross-section stock price trends. Stronger trends are likely when firms are experiencing some persistent and fundamental changes. Following traders and investors in practice, we use simple moving averages to measure trends. Like the popular size, book-to-market or momentum factor, our trend factor is a spread portfolio of buying stocks with the highest expected returns as forecasted by trends and selling those with the lowest forecasted expected returns. We find that the trend factor earns a risk-adjusted 3% return per month, more than tripling that of the size, book-to-market and momentum factors. The trend factor has more than five times the Sharpe ratio of the market, and, during the recent financial crisis, it earns 2.88% per month while the momentum factor loses 0.46% per month. The trend factor return is robust to a variety of control variables including size, price, book-to-market, idiosyncratic volatility, liquidity, etc, and is much higher under greater information uncertainty. Moreover, the trend factor explains well the cross-section portfolio returns sorted by short-term reversal and various price ratios (e.g. E/P) as well as industry portfolios, and performs much better than the momentum factor.