Thursday, May 10th, 2007
Testing my stock market beliefs
As I mentioned when reviewing Ken Fisher’s new book, it is frightening the number of market beliefs I hold without having tested them. Since finishing the book I feel that I may have been ‘winging it’.
Fisher believes we need to be more scientific in our approach to investing and ‘test, test, test’ our beliefs to see if they are actually false.
To be fair to myself, there is some basis for the market beliefs I hold:
a) Studying successful investors (Driehaus, O’Neil etc).
b) Practical experience: When I implement my ‘edge’ fully I usually outperform the market. An example is support/resistance. Time and time again I’ve seen stocks arrest their fall when they high a previous trading range, but I have never formally tested this.
c) Reviewing academic research: There is much research that supports, for example, the notion that stocks that have already outperformed and are hitting new highs — along with accelerating earnings and sales growth and profit upgrades — tend to outperform.
But increasingly I agree with Fisher that there needs to be a more solid basis to my beliefs.
Below are my current beliefs, which I define as my ‘edge’. I’m working on ways to test these (though not all are ‘testable’) including taking courses in statistics, which I’m weak at. Perhaps it is all too time-consuming and I can keep piggy backing on the work of others. We’ll see.
Technical analysis beliefs:
1. Stocks hitting new highs tend to persist
2. The trend is your friend, ie stocks that have made big gains tend to keep rising strongly
3. Stocks trading above a rising 50-day and 50-week moving average are superior buys
4. Stocks are supported (resisted) when hitting previous trading ranges (so put stop losses below support)
5. It is best to buy stocks breaking out of sideways trading patterns
Fundamentals:
1. Companies with fast earnings and sales growth rates produce better trends
2. Companies with accelerating sales and earnings growth outperform
3. Companies with high ROE outperform
4. Stocks with support of institutional investors are better
5. As are companies with reasonable debt/equity ratios
6. Companies issuing profit upgrades tend to outperform.
My beliefs on the general market:
1. The ratio of stocks hitting new highs to new lows is a good predictor of future market performance
2. Accumulation (a rise on higher volume) and distribution (fall on higher volume) is a good predictor
3. It is better to buy shares when indices are above their 50-day and 50-week MA
4. You should reduce exposure to the market when there is evidence that general public is entering the market; when IPOs are rampant; when takeover activity becomes frenzied
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