Technical indicators in China "Alpha" far exceed those in the United States, especially in small-cap stocks

The latest UBS quantitative research shows that the performance of the Chinese A-share market significantly outperforms the U.S. market, excelling in both the scale of returns and the breadth of effectiveness.

On September 4th, according to news from the Wind Trading Desk, UBS research found that technical indicators based on price and volume dynamics exhibit remarkable effectiveness in the Chinese A-share market, especially in the small-cap sector, with the excess returns (Alpha) significantly surpassing the mature U.S. market in both "magnitude of returns" and "breadth of effectiveness."

UBS categorizes technical indicators into five major categories: Momentum, Volatility, Intraday Pattern, Volume, and Price-Volume Interaction, and backtested their performance in the Chinese market.

(List of technical indicators)

Among the five categories, the "K-line Shift" (KSFT) factor in the Intraday Pattern category leads with an annualized long-short return rate of 39%, while the "Price-Transaction Volume Correlation" (PTC) factor in the Price-Volume Interaction category ranks first with a risk-adjusted return of 1.7.

UBS emphasizes that the effectiveness of technical indicators is significantly amplified in small-cap stocks. For example, the KSFT factor has an annualized return close to 50% in the CSI 2000 index, far exceeding the 33% in the CSI 300. This "small-cap premium" reflects a higher turnover rate and stronger behavioral biases among investors in this sector.

Additionally, the research report points out that compared to the U.S. market, the performance of technical indicators in China is far superior in terms of absolute returns and strategy breadth. In the U.S., even the best-performing KSFT factor has an annualized return of only between 7% and 15%, while several other indicators recorded negative returns.

Intraday Sentiment Indicators Lead the Five Major Categories of Technical Indicators

UBS research categorizes technical indicators into five major categories: Momentum, Volatility, Intraday Patterns, Volume, and Price-Volume Interaction. Clear leaders have emerged in each category:

• Momentum Indicator Champion: The SLOPE indicator captures the continuity of trends, achieving a 31% annualized long-short return with a risk-adjusted return of 1.4.

(Statistics of long-short trading performance of momentum factors)

• Volatility Indicator Champion: The NATR (Normalized Average True Range) indicator shows that high volatility often predicts lower future returns, with a cumulative return of 300% over 15 years and an annualized return of 20%

(NATR leads in long and short performance among volatility factors)

• Champion of Intraday Pattern Indicators: KSFT (K-line Shift) is the "king of returns" among all factors, achieving an annualized long-short return of up to 39% by capturing the relative position of the closing price within the day's price range, with a risk-adjusted return of 1.7.

(Calculation formula for K-line Shift indicator)

• Champion of Volume Indicators: VMA (Volume Weighted Moving Average) calculates by smoothing volume data, achieving double-digit positive returns over the years, with returns of 34% in 2010, 30% in 2016, and 29% in 2019. The annualized long-short return is 16%.

(Annualized long-short returns of volume factors in China)

• Champion of Price-Volume Interaction Indicators: PTC (Price-Transaction Amount Correlation) measures the consistency between price trends and trading activity, demonstrating robust performance with an annualized long-short return of 27%, a risk-adjusted return of 1.7, and a maximum drawdown of only -15%.

(Calculation formula for price-volume combined indicators)

Importantly, the report notes that even after considering a trading cost of 10 basis points on each side, strong factors like KSFT and PTC can still be profitable.

(Risk-adjusted return rates of indicator champions in A-shares)

A-shares Small Cap Stocks: A Land of Excess Returns

UBS points out that technical indicators exhibit a significant "small-cap premium" in the Chinese market.

In short, these indicators perform far better on small-cap stocks (such as the CSI 1000 and CSI 2000 constituents) than on large-cap stocks (such as the CSI 300 constituents). UBS research indicates:

• K-line Shift Indicator (KSFT): The annualized long-short return in the CSI 2000 index is close to 50%, with a risk-adjusted return of 2.9; while in the CSI 300 index, these figures are 33% and 1.3, respectively
• Price Transaction Correlation Indicator (PTC): The risk-adjusted return in small-cap stocks reaches an astonishing 3.6, while in large-cap stocks it is only 1.2.

In addition, the report data shows that shorting small-cap stock portfolios can generate significant returns, indicating that technical indicators are particularly effective in identifying overvalued or speculative bubble small-cap stocks.

The report believes that this phenomenon stems from the unique ecology of the Chinese small-cap stock market. Higher turnover rates and stronger retail participation behavioral biases amplify the ability of technical indicators to capture market sentiment and speculative behavior.

Comparison between China and the U.S.: Significant Advantages in the Chinese Market

When UBS quantitative analysts benchmarked the backtesting results of the Chinese market against the U.S. market, the differences were striking.

Technical indicators in the Chinese market outperform in both "return magnitude" and "effective breadth."

• Return Magnitude Difference: In the U.S. market, even the best-performing KSFT indicator has annual long-short returns in different market capitalization segments only between 7%-15%, with risk-adjusted returns ranging from 0.3-0.9. The annual return of the PTC indicator is also only 7%-9%. This sharply contrasts with KSFT's returns of over 30% in the Chinese market.

(Annual long-short returns of technical indicators in different market capitalization segments)

• Effective Breadth Difference: In the Chinese market, multiple signals from the five major categories can generate excess returns. However, in the U.S. market, aside from KSFT and PTC performing reasonably well, indicators like NATR and VMA even produced negative returns, indicating that the effectiveness of technical signals is very limited.

(Only in the case of long-term buying, the annual performance of technical indicators in different market capitalization segments)

The report attributes this significant difference to structural factors in the two markets. The higher retail participation in the Chinese market, the globally leading extremely high turnover rate (the annual turnover rate of small-cap A-shares can reach over 1900%, while U.S. stocks are only 200-400%), and the resulting stronger behavioral biases collectively create more powerful profit opportunities for technical indicators.

In contrast, the U.S. market is more institutionalized, with higher price discovery efficiency, naturally resulting in smaller arbitrage opportunities for technical signals