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Investors are inattentive to continuous information as opposed to discrete information, resulting in underreaction to continuous information. This paper aims to examine if the well-documented return predictability of the strategies based on the ratio of short-term to long-term moving averages can be enhanced by conditioning on information discreteness. Anchoring bias has been the popular explanation for the source of underreaction in the context of moving averages-based strategies. This paper proposes and studies another possible source based on investor inattention that can potentially result in superior performance of these strategies.

The paper uses portfolio sorting as well as Fama-MacBeth cross-sectional regressions. For examining the role of information discreteness in the return predictability of the moving average ratio, the sample stocks are double-sorted based on the moving average ratio and information discreteness measure. The returns to these portfolios are computed using standard approaches in the literature. The regression approach controls for various well-known return predictors.

This study finds that the equally-weighted monthly returns to the long-short moving average ratio quintile portfolios increase monotonically from 0.54% for the discrete information portfolio to 1.37% for the continuous information portfolio over the 3-month holding period. This study observes a similar pattern in risk-adjusted returns, value-weighted portfolios, non-January returns, large and small stocks, for alternative holding periods and the ratio of 50-day to 200-day moving average. The results are robust to control for well-known return predictors in cross-sectional regressions.

To the best of the authors’ knowledge, this is the first paper to document the significant role of investor inattention to continuous information in the return predictability of strategies based on the moving average ratios. There are many underreaction anomalies that have been reported in the literature, and the paper's results can be extended to those anomalies in subsequent research.

The findings of this paper have important practical implications. Strategies based on moving averages are an extremely popular component of a technical analyst's toolkit. Their profitability has been well-documented in the prior literature that attributes the performance to investors' anchoring bias. This paper offers a readily implementable approach to enhancing the performance of these strategies by conditioning on a straightforward measure of information discreteness. In doing so, this study extends the literature on the role of investor inattention to continuous information in anomaly profits.

While there is considerable literature on technical analysis, and especially on the performance of moving averages-based strategies, the novelty of this paper is the analysis of the role of information discreteness in strategy performance. Not only does the paper document robust evidence, but the findings suggest that the investor’s inattention to continuous information is a more dominant source of underreaction compared to anchoring. This is an important result, given that anchoring has so far been considered the source of return predictability in the literature.

The purpose of this paper is to examine the combined performance of momentum and a gross profitability-based strategy. The motivation stems from the strong performance of momentum on the short side and profitability on the long side, suggesting a potentially superior combined strategy. Gross profitability is also a measure of firm quality, so that another motivation is to contribute to a growing literature on factor-based investing that includes momentum and quality as potential factors.

The empirical approach employed in the paper is standard in the asset pricing literature. The firms are sorted into portfolios based on profitability and momentum, and the combined performance is studied through independent double sorting. Both value-weighted and equally weighted returns are reported in case of key empirical results.

The combined strategy results in superior performance. Specifically, the strategy produces results 2.75 greater than the momentum strategy, and about four times as high as the profitability strategy. The strategy also has much higher Sharpe ratio that improves further when combined with size and value strategies.

The research has significant implications for academics and practitioners alike. A new investment strategy that has not been explored in the literature is presented. The superior performance of the strategy presents a challenge for the market efficiency, and would be of interest to academics and practitioners working in the area of investment management.

There has been a growing interest in multi-factor investing in recent years. The paper documents that superior performance is achieved by combining two of the popular factors, namely profitability and momentum.

The research is the first to study the combined performance of profitability and momentum, and provide evidence on the superiority of the combined strategy.