There’s a random element in stock-price movements that you just can’t get away from.
Stocks sometimes ignore bad news for long periods, then suddenly take note of it and collapse. Stocks may overreact to bad news, or react to downbeat but irrelevant news. To top it off, stocks that are headed for a big rise often start their move with a slump.
You can’t overcome this random element by intense study, reading charts, expensive computer programs or stock investing advice that aims at fine-tuning your market timing. (But our system can help you minimize this random element. Read on to find out how.)
In a column on Marketwatch.com entitled “El Cid(s) Ride On,”* financial journalist Peter Brimelow examined the performance of the stock investing advice of a number of investment newsletters through June 2009. His data came from the Hulbert Financial Digest, which is generally thought of as the “bible” of investment newsletter performance measurement. The results provide a good example of this random element at work.
Hulbert’s top-performing newsletter hadn’t published an issue for several months
Through June 2009, the top performer on Hulbert’s list was John Thibault’s Equities Special Situations, which was up 115.4%, compared to 4.5% for the Wilshire 5000 Total Stock Market Index (dividend reinvested). The Wilshire aims to measure all publicly traded stocks in the U.S.
What stood out about this newsletter is that it hadn’t published an issue since late 2008.
Newsletter beats the index — despite editor’s absence
Another example is Chris Temple’s National Investor, which was up 18.6% through June, and had lost only 3.93% over the previous 12 months (compared to a loss of 26.4% for the total-return Wilshire 5000). The letter had also soundly beaten the Wilshire over the previous three- and five-year periods.
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The kicker? Brimelow says, “…National Investor’s editor, Chris Temple, was serving a six-year sentence for defrauding money management clients.” His newsletter had been updated only intermittently.
The random element in stock investing worked in favour of these newsletters in the short term, but this wasn’t always the case in the long run: while John Thibault’s Equities Special Situations led all newsletters on Hulbert’s list for the year through June, the letter’s performance over the longer-term is, to quote Brimelow, “quite a bit more depressing.”
That’s certainly true: over the previous ten years, the letter posted an annualized loss of 4.07%, compared to an annualized loss of 1.32% for the total-return Wilshire.
Stock investing advice: How to neutralize the random element in stock-price movements
Because you can’t reliably profit from this random element over the long term, we recommend that you invest in such a way that the random fluctuations even out over long periods. That way, you profit from the near-inevitable long-term rise in the value of high-quality companies.
That means you need to be particularly conscientious about following our three-part stock investing advice: mainly invest in well-established companies, spread your money across the five main economic sectors; and avoid stocks that are in the broker/public relations limelight.
This strategy is far more likely to make money for you than, say, market timing — trying to figure out the market’s next move, and buying and selling to profit from it. It also works much better than sector rotation (trying to figure out, for instance, which groups or kinds of stocks will rise fastest when the market bottoms).
You are also more likely to hang on to your best picks, rather than selling them prematurely. After all, your best picks are those that do way better than you ever expected, and frequent trading will lead you to sell your best picks when they are just getting started. It also pushes up your commission expense.
* El Cid was an eleventh-century Spanish military leader. According to legend, his corpse, dressed in armor and lashed to his horse, won a battle by panicking the enemy.
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