Contrary Wins the RaceLongtime readers may remember that many moons ago I helped build electronic trading software (for three different companies), trading in stocks, bonds, and stock options for hedge funds. I learned a lot about how those investments worked in the process; more, really, than I ever wanted to know :) What I learned that applied to an individual investor can be summarized as follows:
It wasn’t easy to make money in most markets in 2015. The investors who did the best are the ones who defied conventional wisdom. While many star traders had a rocky year as consensus predictions persistently came up short, those who did well employed strategies including betting against already downtrodden energy stocks and taking a contrarian stance on that most golden of stocks, Apple.
- Invest in equities (stocks) only through index funds or similarly diversified algorithmic strategies.
- Don't listen to anyone advising you to choose particular single stocks (not even Warren Buffet, and certainly not some idiot reported in the Wall Street Journal, Fox News, or USA Today).
- Don't touch bonds, most especially don't touch municipal bonds. Their credit ratings are faked.
- Find other investment vehicles, even if unconventional, so that you don't have all your investments in stocks. For us, that's currently real estate, though I'm still looking for other attractive alternatives.
The reason is a direct result of my work in the electronic trading industry. One of my bosses was very interested in what the industry calls “algorithmic trading”. Basically that's stock picking (choosing what to buy or sell) by a computer program, and often doing so at very high speeds that a human could not do. That boss asked me to undertake a study using publicly available (though expensive!) data. He wanted me to figure out which human traders had the best, consistent trading record. Then he wanted to build an algorithmic trading system that duplicated what that human trader did (assuming we could figure it out).
Well, that project never got past the first stage. You see, when I completed the data analysis part (using 25 years of trading data, and looking only at traders with at least a 10 year record), we found zero human traders who consistently beat the Standard and Poors index. Not one. Nada. Zip. Nobody. This was inconsistent with the widely believed lore in the business, but completely consistent with previous academic studies.
My boss didn't believe my results, so he had me do a second study: this time of “analysts”: those people who spend their entire working life trying to predict the future price of stocks. Generally these analysts work within a small segment of the market (say, mining stocks, or auto makers); sometimes they work with only a single (large) company, like Apple or GM. These results were even more interesting: the analysts did significantly worse than simple exponential growth models. For instance, if we took 5 years of Apple stock prices, figured out what the annual percentage growth was, on average, and then projected that forward for the next 10 years – we got a more accurate result than any analyst. The analysts had a significant bias to the upside – that is, their predictions were, on average, rosier by a good margin than the actual results. You can supply your own reasons for why that might be so. I don't actually care, myself, because the one piece of useful information in there for an individual investor is that none of these analysts were better than the simplest mathematical model one can make. That is also completely consistent with the academic studies showing that you're best off investing in an index (or equivalent) fund...