Profitability of Short-Term Contrarian Strategies: Implications for Market Efficiency

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Abstract
In recent years, several researchers have argued that the stock market consistently overreacts to new information, which, in turn, results in price reversals. Lehmann and others showed that a contrarian can make substantial profits in the short run by simply buying losers and selling winners. We, however, demonstrate that these profits are largely generated by the bid–ask bounce in transaction prices; accounting for this “bounce” by using bid prices eliminates all profits from price reversals for NASDAQ-NMS stocks and most of the profits for NYSE/AMEX stocks. Moreover, any remaining profits (regardless of their source) disappear at trivial levels of transactions costs.

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