Mean-reversion in equity residuals - betting that stocks which drift away from their sector will snap back - generated Sharpe ratios above 1.4 through the late 1990s. Then something broke. After 2003, the same signals that printed money for years started bleeding out. But there's a fix: weigh your signals inversely by trading volume, and the strategy claws back a Sharpe of 1.5 through 2007, including surviving the August quant meltdown.
The insight is simple: a stock that drops on low volume probably overreacted. A stock that drops on high volume might know something. Weight accordingly.
The Volume Signal That Rescued Mean-Reversion…
Mean-reversion in equity residuals - betting that stocks which drift away from their sector will snap back - generated Sharpe ratios above 1.4 through the late 1990s. Then something broke. After 2003, the same signals that printed money for years started bleeding out. But there's a fix: weigh your signals inversely by trading volume, and the strategy claws back a Sharpe of 1.5 through 2007, including surviving the August quant meltdown. The insight is simple: a stock that drops on low volume probably overreacted. A stock that drops on high volume might know something. Weight accordingly.