Stock price reversals following extreme weekly returns

The objective of this study is to test whether stock price behavior is predictable following extreme returns. Specifically, I test for the occurrence of price reversals after extreme weekly gains or losses in stock returns. Price reversals may indicate market overreaction and potentially profitable contrarian trading strategies. This study examines the occurrence of these price reversals by analyzing abnormal returns for stocks that have experienced extreme weekly returns (gains and losses of 50% or more). Evidence of price reversals is found for both gain and loss events. Abnormal returns following extreme gains are negative and increase in size gradually, peaking with a market-adjusted buy-and-hold return of -20.33% in week fifty. Abnormal returns following extreme losses are positive in early weeks, with a spike in the first week of 9.31%. However, price reversal following losses is short-lived as abnormal returns decline after week ten, ending with a negative abnormal return of -2.54% in week fifty. Thus, extreme gains appear to signal market overreaction that is corrected for gradually. Extreme loss events exhibit overreaction in the short-term and underreaction in the intermediate-term. A magnitude effect is observed following extreme gains and extreme losses. To test for the robustness of results, we employ several measures of abnormal returns and a survivorship bias adjustment is made for loss events. The robustness tests confirm the results.