A Study On The Theory And Application Of Stock Reverse Transaction Strategy Based On Prospect Theory

It is of great significance for stock investment management to accurately identify the future trend of stock price.And it is a continuing concern to find stable and effective trading strategies.Since the "reversal effect" and "momentum effect" were proposed,many foreign scholars have proved that these two effects generally exist in the stock markets of all countries in the world,and the momentum trading strategies established therefrom have also achieved sustained and stable returns.With the maturity of the research on these two financial anomalies abroad,domestic scholars have tried to apply the famous momentum trading strategies abroad to the Chinese stock market in order to find the law of price changes.However,the results are unsatisfactory.The reason is that,unlike foreign mature capital markets,Chinese stock market is vulnerable to the influence of national macro-control policies,and the investors' irrational behaviors are significant.In such situation,can momentum or reverse trading strategy become an effective trading strategy in China's stock market?In view of the fact that the traditional momentum trading strategy can not achieve sustainable and stable returns in the Chinese market,this paper,based on the prospect theory,incorporates anchoring effect and disposition effect into the framework of evolutionary game model,and constructs a theoretical model to study the formation mechanism of momentum and reversal effect of stock prices and the dynamic adjustment process of equilibrium.In addition,based on the prospect theory,an "anchor-disposal" reverse trading strategy is constructed to identify the reversal trend of stock prices,and the strategy is compared with the traditional momentum strategies.The main conclusions of this paper are as follows:Firstly,anchoring effect and disposition effect can explain the causes of momentum and reversal effects.Investors anchor historically low prices when stock prices rise and historically high prices when stock prices fall.If the utility of conforming to the trend is high enough,investors will adopt the same behavior,resulting in momentum effect.Under the influence of disposition effect,investors' utility decreases with the increase of the deviation between stock price and anchor price.Investors will gradually change their trading behavior,resulting in a weakening of momentum effect and eventually a reversal effect.Secondly,the trading strategy based on prospect theory can be used for investment management.The "anchor-disposition" trading strategy constructed in this paper can effectively capture the reversal point of stock price trend.The most profitable strategy is to anchor the highest/lowest price in 8-12 weeks,which is consistent with the characteristics of short average holding time and high turnover rate in Chinese stock market.It also shows that anchoring effect and disposition effect have significant impacts on investors in China's stock market.Compared with the traditional momentum trading strategies,the strategy constructed in this paper yields higher returns and still has significant returns after deducting transaction costs.Therefore,the strategy has strong practicality.Compared with the existing research,the main innovations of this paper include: Firstly,the prospect theory is incorporated into the framework of evolutionary game model to analyze the formation mechanism of momentum effect and reversal effect.Secondly,this paper constructs a reversal trading strategy suitable for China's stock market by taking the historical highest and lowest prices as anchoring points,and the degree of current stock price deviating from anchoring prices as indicators to measure the impacts of disposition effect.Thirdly,this paper also discusses the effectiveness of the strategy in the presence of transaction costs,to make up for the shortcomings of previous scholars on this issue.