Google “average time a stock is held.” You will come up with figures that typically run around 20 seconds. High frequency trades (HFT) dominate trading volume on the US exchanges.
All of which suggests the focus on the predictability of stock returns needs to position more on intervals lasting seconds or minutes, rather than daily, monthly, or longer trading periods.
So, it’s logical that Michael Rechenthin, a newly minted Iowa Ph.D., and Nick Street, a Professor of Management, are getting media face time from research which purportedly demonstrates the existence of predictable short-term trends in the market (see Using conditional probability to identify trends in intra-day high-frequency equity pricing).
Here’s the abstract –
By examining the conditional probabilities of price movements in a popular US stock over different high-frequency intra-day timespans, varying levels of trend predictability are identified. This study demonstrates the existence of predictable short-term trends in the market; understanding the probability of price movement can be useful to high-frequency traders. Price movement was examined in trade-by-trade (tick) data along with temporal timespans between 1 s to 30 min for 52 one-week periods for one highly-traded stock. We hypothesize that much of the initial predictability of trade-by-trade (tick) data is due to traditional market dynamics, or the bouncing of the price between the stock’s bid and ask. Only after timespans of between 5 to 10 s does this cease to explain the predictability; after this timespan, two consecutive movements in the same direction occur with higher probability than that of movements in the opposite direction. This pattern holds up to a one-minute interval, after which the strength of the pattern weakens.
The study examined price movements of the exchange traded fund SPY, during 2005, finding that
.. price movements can be predicted with a better than 50-50 accuracy for anywhere up to one minute after the stock leaves the confines of its bid-ask spread. Probabilities continue to be significant until about five minutes after it leaves the spread. By 30 minutes, the predictability window has closed.
Of course, the challenges of generalization in this world of seconds and minutes is tremendous. Perhaps, for example, the patterns the authors identify are confined to the year of the study. Without any theoretical basis, brute force generalization means riffling through additional years of 31.5 million seconds each.
Then, there are the milliseconds, and the recent blockbuster written by Michael Lewis – Flash Boys: A Wall Street Revolt.
I’m on track for reading this book for a bookclub to which I belong.
As I understand it, Lewis, who is one of my favorite financial writers, has uncovered a story whereby high frequency traders, operating with optical fiber connections to the New York Stock Exchange, sometimes being geographically as proximate as possible, can exploit more conventional trading – basically buying a stock after you have put in a buy order, but before your transaction closes, thus raising your price if you made a market order.
The LA Times has a nice review of the book and ran the above photo of Lewis.