Hands-On Machine Learning for Algorithmic Trading

Value factors

Stocks with low prices relative to their fundamental value tend to deliver returns in excess of a capitalization-weighted benchmark. Value factors reflect this correlation and are designed to provide signals to buy undervalued assets, that is, those that are relatively cheap and sell those that are overvalued and expensive. For this reason, at the core of any value strategy is a valuation model that estimates or proxies the asset's fair or fundamental value. Fair value can be defined as an absolute price level, a spread relative to other assets, or a range in which an asset should trade (for example, two standard deviations).

Value strategies rely on mean-reversion of prices to the asset's fair value. They assume that prices ...