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The effect of historical return on creating the momentum phenomenon and

return reversal stock in Tehran Stock Exchange
Atefeh Sadat Aghamiri Ardestani
M.A. Student, Department of Management, Industrial Branch, Islamic Azad University,
Central Tehran, Iran
Aghamiri_atefeh@yahoo.com
Arefeh Fadavi Asghari
Assistant Prof, Department of Management, Industrial Branch, Islamic Azad University,
Central Tehran, Iran
Tahmoures Sohrabi
Assistant Prof, Department of Management, Industrial Branch, Islamic Azad University,
Central Tehran, Iran

Abstract
Present research aims to investigating the effect of historical return on creating the momentum
phenomenon and return reversal stock in Tehran Stock Exchange. Required information was
gathered by the resource library and historical information by techniques of portfolios in a 10year period. The Descriptive Statistics and Regression were used to analyze data. The result of
this study showed that historical return create momentum and return reversal. So we can say
that the new orientation bias, indicators and means of overreaction is formed in the behavior
of investors in Tehran Stock Exchange. At the end based on research findings
recommendations were presented.
Keywords: Historical Return - Momentum - Return Reversal Stock - Tehran Stock
Exchange.

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Introduction
In previous years, before the development classical theories of finance, some economists,
such as Adam Smith, Fisher, Keynes and Markowitz believed that the individual psychology
phenomena, affect on the stock price. During this time, economists were closely related to
psychology. For example, Adam Smith published a paper entitled Theory of Moral
Sentiments in which explained the principles of behavioral psychology, when behavioral
phenomena were discussed sporadically. Financial classical theories faced with significant
growth and in the late 1970s, achieved its climax with the introduction of the efficient market
hypothesis and the capital asset pricing model. This theory is based on two main paradigm of
rational behavior and the efficient market hypothesis that faced with challenge of the market
anomaly.
Statement of Problem
During recent decades irregularities in the financial markets caused that Standard financial
theory have failed to explain them. Some of these irregularities are the negative and positive
correlation of stocks in the short term, overreaction of investors, effect size of companies In
return, P / E ratio and its effect on efficiency, abnormal returns in early January, weekend
effect, end month effect, end year effect, transactions made within the company, etc. This
irregularity shows that besides the rational theories, behavioral and psychological variables
influence on investors decision.
Literature review
In recent years, financial markets have witnessed sharp fluctuations in stock prices highly
influenced by the behavior of investors, their perspectives, insights and experiences of social,
economic and political variables. As a result, there is a need to examine psychological
patterns and their impact on financial markets. The behavioral finance theory is a new
psychological approach for understanding the behaviors of investors and markets.
Many financial and economic theories are based on the hypothesis that individuals act
rationally in the face of economic events. Rational decision-making means making the
decisions which maximize the chance of achieving the goals and objectives (Pompian, 2006).
However, it is necessary to consider the probability that in economics, when trying to find
solutions to empirical puzzles, some factors are not fully rational (Brabazon, 2000).
In standard finance theories, investors behavior and the effect of their personality is assumed
to be constant. This approach which is based on how individuals should behave is called
the normative approach. On the other hand, the behavioral approach identifies cognitive
errors and emotions that often affect financial decision. Makers and result in poor decisions.
This approach emphasizes human behavior. In fact, the behavioral finance approach studies
how individuals behave in a financial context. Therefore, it can be stated that behavioral
finance is combination of classical economics and finance with psychology and decisionmaking sciences, which seeks to explain financial anomalies (Fuller, 1998).
In the financial literature on stock price analysis and investment in financial assets, three
methodologies have been broadly applied: fundamental analysis, technical analysis and
behavioral finance. Factors mentioned in the previous section are analyzed here based on
these approaches. Fundamental analysis identifies factors determining the intrinsic value of a
financial instrument and decisions are made based on this. P/E, EPS and dividend per share
(DPS) are among the factors in this category. Fundamental factors are a result of a firms
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micro environment and macro-environment (Xu and Wu, 2006). Therefore, fundamentalists
reactions are based on the analysis of underlying economic conditions (Oberlechner, 2001).
Considerable research has been conducted on the advantage of using fundamental analysis
techniques to examine stock markets. Research by Campbell (1987), Cochrane (1991), Fama
and French (1989), Renshaw (1993), Campbell and Sheller (1988), among many others,
indicates that annual and quarterly stock return can be predicted using P/E ratio, stock profit,
dividend yield, economic variables and firms special conditions. Abarbanell and Bushee
(1998), Fama and French (2006), Wu and Xu (2006) and Cole et al. (2008) have also
emphasized the fundamental approach in their research. Technical analysis advocates
(chartists), believe that the price reflects all the information available in the market.
Therefore, stock price and volume data determine future stock price movements (Blume et
al., 1994). As a matter of fact, this approach holds that information has already affected price
and is based on stock price return and predictability patterns. Indices and patterns used in this
approach include simple moving average (SMA), weighted moving average (WMA),
exponential moving average (EMA), relative strength index (RSI), commodity channel index
(CCI), %K and %D stochastic, Williams %R (WIL) and money flow index (MFI). Despite
chartists belief in the profitability of this method, extensive research has been conducted on
this issue in the past few decades which has yielded contradictory results. Initial studies by
Alexander (1961), Fama and Blume (1966), Dryden (1970), Cunningham (1973), Rozeff
(1974) and Dann et al. (1977), among others, emphasized the ineffectiveness of technical
methods for stock price prediction. Conversely, some studies such as those conducted by
Ming-Ming and Siok-Hwa (2006), Ellis and Parbery (2005), Marshall and Cahan (2005),
Anderson and Faff (2008), Letamendia (2007), Armano et al. (2005) and Zarandi et al.
(2009) emphasize the usefulness of this approach.
As previously mentioned, behavioral finance aims to connect financial science and other
social science disciplines. Accordingly, it can be said that personality plays a prominent role
in this approach. Decision-making is so intertwined with the deciders psychological
characteristics that it is impossible to study the former without taking the latter into account.
The importance of the many individual differences between people is that the information
needed for decision-making is understood and interpreted with respect to these differences.
Conventional economic theories, such as the modern portfolio theory and the efficient market
hypothesis (EMH), do not explain investors partiality and market irregularity. There are at
least five major areas in which neoclassic economic theory cannot explain market results and
investors real behavior. These areas include trading volume, capital market volatility,
dividends, equity premium puzzle and predictability (Thaler, 1999). Cognitive errors which
affect investors decisions and consequently market results include anchoring, information
availability bias, information confirmation bias, disposition effect, framing and reference
dependence, illusion of control, optimism bias, overconfidence bias, overreaction,
representativeness and under reaction (Flynn, 2008). Considerable research has also been
conducted to identify investors psychological factors including those conducted by
Ritter (2003), Shapira and Venezia (2005), Kim and Nofsinger (2007), Wurgler et al. (2010)
and Lu et al. (2012).
Historical background
To forecast future stock prices, fundamental analysis combines analysis of economics,
industry, and companies in order to establish a stocks current fair value and forecast future
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value. Many studies have been conducted according to the fundamental approach. Quirin et
al. (2000) surveyed the US oil and gas exploration and production industry and concluded
that there is a significant relationship between a number of the fundamentals and both the
market value of equity and cumulative stock return. Tang and Shum (2003) documented a
significant relationship between political shocks and stock returns. Clubb and Naffi (2007)
investigated the fundamental approach with respect to British firms. The results emphasized
the significant role of the fundamental approach in the prediction of stock return. Edirisinghe
and Zhang (2007a) developed a generalized data envelopment analysis (DEA) model to
analyze a firms financial statements over time in order to determine a relative financial
strength indicator (RFSI) that is predictive of the firms stock price returns. Cole et al. (2008)
documented that that stock market index returns affect future economic growth and the two
elements also interact. Samaras et al. (2008) adopted the multi-criteria decision support
system and portfolio management to evaluate the strengths and weaknesses of individual
stocks based on the method of fundamental analysis. Yildiz and Yezegel (2010) performed
fundamental analysis and cross-sectional prediction of stock return with neural network
technology. The results highlighted neural networks ability to predict future returns in
NYSE/AMEX/Nasdaq securities for the period 1990-2005.
On the other hand, over the years, many researchers have examined the technical approach.
Mizuno et al. (1998) used Japanese stock data and utilized variable length moving average
(VMA) and relative strength indicators (RSI) to construct a stock prediction model that
yielded empirical findings robust to the alternative methods. Lo et al. (2000) proposed a
systematic and automatic approach to technical pattern recognition using nonparametric
kernel regression, and applied the proposed method to a large number of U.S. stocks from
1962 to 1996. The findings showed over the 31-year sample period, several technical
indicators provide incremental information. In their study of Microsoft, Intel, and IBM, Wang
and Chan (2006) employed decision trees integrated with RSI to study timing points of stock
purchase. The research showed this method can accurately predict optimal buying timing and
enhance investors returns. Liu and et al. (2007) examined the use of technical analysis and
the PXtract algorithm in predicting stock prices in the Hong Kong stock market. The results
showed that the PXtract algorithm in combination with technical analysis can predict stock
price movements. Groenewold et al. (2008) investigated the efficiency of technical analysis
methods. Nguyen and Chen (2008) researched institutional investors herd behavior and its
effect on stock prices. They cited the reason for their study as the fact that when institutional
investors become the main players in the capital market, their herd behavior may result in
stock price volatility and consequently return volatility. Rosillo et al. (2013) examined the
result of the application of the RSI, Moving Average Convergence Divergence (MACD),
Momentum and Stochastic indicators in different companies of the Spanish continuous
market. They used these indicators to give purchase and sale recommendations to small
investors.
While conventional academic finance emphasizes theories such as the modern portfolio
theory and the efficient market hypothesis, the emerging field of behavioral finance
investigates the psychological and sociological issues that impact the decision-making
process. Many studies have examined the behavior of investors and its impact on the way
they purchase and sell stock. For example Daniel et al. (1998) presented a model in which
investors underreact to public signals, motivated by different psychological biases. They
predicted that prices would overreact to private signals but underreact to public ones. Shefrin
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(2000) described behavioral finance as the interaction of psychology with the financial
actions and performance of practitioners (all types/categories of investors). He recommended
that these investors should be aware of their own investment mistakes as well the errors of
judgment of their counterparts. Caparrelli et al.
(2004) studied the herding effect in the capital markets by using data from the Italian Stock
Exchange. They concluded that herding can be observed in extreme market conditions.
Kothari et al. (2006) studied the stock market reaction to aggregate earnings news. They
found that the relation between returns and earnings is substantially different in aggregate
data. Cheng (2007) suggested that overconfidence behavior is the most common human
characteristics, reflecting a tendency to overestimate ability, chances for success and the
probability that someone will gain positive outcomes, and the accuracy of the knowledge
possessed. Hoffmann et al. (2012) examined behavioral aspects (framing, risk aversion) of
Covered Call Writing. They found highly significant empirical evidence for a pronounced
framing effect with respect to different covered call designs with equal net cash flows as well
as covered calls in general. They also highlighted the limited amount of empirical evidence
demonstrating a relationship between risk aversion in the domain of gains and a preference
for covered calls.
The theoretical Framework of the Research
This research is descriptive, experimental and ex-post facto research that was performed
through observational data analysis. In this type of research, a course of events or observation
period and the estimate period will be considered.
Methodology of the Research
According to the implications of theories in response to the questions raised above, the
following hypotheses are tested:
The main hypothesis:
There are a significant relation between stock historical returns and stock future returns.
The sub hypotheses:
1. Companies that their returns have a higher growth in the past, in the short term would
be to achieve higher returns.
2. Stock of companies that their returns in the past have a higher growth, is pricing more
than the actual and in the long-term will be achieved lower returns.
Analyzing the Data of the Research:
In following, results of research data analysis are presented: according to the analytical
research model and for hypotheses examination, the linear regression was used.
Hypotheses Test
According to regression output there's a relationship between historical returns and future
stock returns in the short term at a significance level of 95% is confirmed. It could be said,
historical returns of stocks that higher (lower) will be achieved in higher (lower) short-term
returns.
In summary it can be said, historical returns in the short term lead to continued returns and in
the long term lead to return reversal. Conclusions the results indicate that in Tehran Stock
Exchange Historical returns in the short term lead to create constancy of returns and in the
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long term will cause return reversal. Investors in Tehran Stock Exchange have found a new
orientation. According to the results of the recent past and putting it in special classifications,
future predictions are doing.
Conclusion and Discussion
In this study, the effect of historical returns on price formation and future stock returns has
been measured. For this purpose, in the second section some concepts such as continuity of
return, Overreaction explained. In the third quarter the methodology and how to test
hypotheses have been examined. In the fourth quarter, according to research method consists
winner and loser portfolios and their returns on short-term performance and long-term periods
is examined. Then, using linear regression analysis and the relevant test research hypotheses
were tested and the results are presented. Tests to verify the historical factors on future stock
returns in Tehran Stock Exchange shows that only historical returns and financial
performance lead to prolong the returns. But in this study, there was no evidence of the
existence of continuing return of volumes and stable historical performance. From behavioral
finance point of view, create constancy of performance caused by the historical financial
performance with new positivism bias is interpreted. Also the results of this study show, the
factors that could lead to return reversal are the historical trading volume, historical returns
and historical operating profit, while the return reversal of historical financial performance
and stable historical financial performance was not confirmed. So we can say that the
behavior of investors in the Tehran Stock Exchange in the face of historical factors such as
turnover, efficiency and financial performance indicator is in compliance with bias.
Research suggestions
Investors beside of fundamental analyzes, use from behavioral and techniques
analysis.
The use of expert consultants in the field of behavioral finance.
Using asset allocation strategies.
Holding seminars, training courses and practical courses in the field of behavioral
finance to enhance the knowledge of investors.
The Stock Exchange is inserted the important price points, such as maximum and
minimum prices in the web site (www.tsetmc.com)
The Stock Exchange for more transparent trading, review the provisions relating to
volume basis and transaction tied.
Create a category for growth and value stocks and calculated their efficiency in the
past year can help to increase the awareness and market efficiency.
The other research suggestions
It is recommended that future researchers to use from this method in other
organizations and compare the results with this research.
It is recommended that future researchers to use from other method.
Return reversal of historical stock returns, be examined according to industry.
Limitations of the research

Some people do not cooperate in completing the questionnaire.

The lack of a standard questionnaire for surveys the research purposes.

Lack of scientific sources about this subject.

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Time-limited for further investigation.

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