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Tuesday, July 18, 2006

Can You Make Money Trading Against Jim Cramer?

Jim Cramer of the CNBC show Mad Money is one of the most well known personalities in the investment world. Few people who know him are indifferent about him - either you love him or hate him.

But love him or hate him, he does have a lot of viewers (somewhere between 350,000 and 400,000 at last count). With all those viewers, what effect does a Cramer "buy" recommendation have on a stock's price? Professors Engelberg, Sasseville, and Williams of Northwestern University recently posted a study on SSRN that provides some answers:
  • For the smallest quartile of recommended stocks, average cumulative abnormal overnight is 5.19% (and 1.96% for the overall sample)
  • The returns on these stocks completely reverse within 12 trading days.
  • Recommended stocks have abnormally high trading volume, buy-sell imbalance, and short sales on the day following the recommendation
  • The adverse selection component of the bid-ask spread falls significantly following the recommendation (note: this means that tit's less likely that the market maker is facing traders with inside information)
  • There's a price run-up the day of the recommendation (this is surprising, since the show is recorded, and doesn't air until 30 minutes after the market's closing).
Read the whole thing here.

The most likely interpretation of these patterns is that you have a lot of uninformed traders buying stocks the next day after Cramer recommends them, and they push the stock's price above it's fundamental value. Arbitrageurs are aware of this pattern and start short selling the stock at the same time. Over a fairly short period of time (12 days), their trades drive the stock's prices back down to their "pre-Cramer recommendation" levels.

Note: the authors caution that this might not be a tradeable strategy for a number of reasons. One important reason is the dynamic nature of information about anomalies - as people discover them and publish papers about them, rational players start trading based on the information. This in turn ends up driving future profits from the strategy down to zero.

But all in all, a very interesting paper, and a great example of an apparent market inefficiency.

HT: Marginal Revolution

In case you're interested, here's a study that reports on Cramer's track record over the longer term.

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