Exploiting Downside Volatility: A Trading Strategy for Capturing Excess Returns from Intraday Price Reversals

This study explores an intraday downside volatility trading strategy (DVTS) that seeks to capture excess returns by exploiting intraday price reversals following downside moves in stock prices. Using historical data from S&P 500 constituents between 2021 and 2024, the DVTS identifies stocks experiencing significant intraday declines and downside volatility, executes trades at estimated low prices based off of historical data, and closes positions at the end of the trading day. The strategy uses the historical data available on each trading day and accounts for trading costs, meaning that it would have been possible to implement in real time during the studied period. To evaluate the strategy's effectiveness, a return analysis compares DVTS performance against a passive S&P 500 buy-and-hold benchmark, while regression analysis investigates the determinants of trade frequency and profitability on three levels: the trade level, the portfolio level, and the stock level. Results indicate that the DVTS outperforms the S&P 500 in both absolute and risk-adjusted terms, generating an annualized return of 24.65% versus 11.02% for the S&P 500 index and achieving a Sortino Ratio of 3.22 compared to 0.54. Regression results show that trade returns are associated with larger downside moves from open price to low price (-0.319, p<.001), higher intraday returns from open to close (1.003, p<.001), higher absolute volume (.020, p<.001), lower volume relative to average level (-.110, p<.001), lower market cap (-.022, p<.001) and higher beta (.106, p<.001). Daily portfolio returns (when up to 10 trades per day are allowed) are associated with more trades executed (.245, p<.01) and with a higher S&P return percent (.018, p<.001). When all trades were considered, portfolio returns were correlated with a higher VIX (.015, p<.05), and a higher S&P return percent (.355, p<.001). At the stock level, higher trade frequency correlates with greater average volume (1.322, p<.01), smaller average market cap (-0.796, p<.01), and tighter average spread (more liquidity) (-1.257, p<.01). Increased average returns across stocks are associated with higher beta (0.142, p<.01). These findings suggest that intraday price reversals present a viable trading opportunity, providing an alternative to passive investment strategies for investors seeking to exploit short-term market inefficiencies. Further research could refine the strategy using regression results to further enhance profitability.