This study introduces short-term moving-average distance (SMAD)—the gap between recent prices and their 10-day average. Investors overreact to salient price moves, making SMAD a strong return predictor and tool for exploiting mispricing.
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Abstract
Motivated by the recency bias and the belief-adjustment model, we propose a new predictor of stock returns based on the distance between the end-of-month price and past-10-day moving average, which we term short-term moving-average distance (SMAD). We propose that investors tend to overreact to the information embedded in SMAD when extreme short-term prices are more salient, leading to a negative return predictability. Our empirical results confirm this prediction. We further confirm the validity of the salience theory in explaining the SMAD premium. Finally, we show that SMAD is effective in predicting the return premia of the mispricing anomalies.