able to identify mispriced investments isn’t nearly enough; you also must be able to identify where mispriced investments are still likely to be found.
If investors are to prosper from inefficient markets, they have to evaluate which markets still are inefficient. Areas like microcap stocks or high-yield bonds, where index funds can’t easily maneuver, offer some promise. Areas increasingly dominated by index funds offer little.
An individual investor can still benefit from time arbitrage: You can buy into a stock when bad news poisons the price with negative emotion and then hold for years until euphoria finally returns. That’s a luxury most institutional investors no longer have.
But the skills that worked in inefficient markets rarely yield sufficient returns in efficient markets to make them worth bothering with.
Take it from one who has been there.
About Jason Zweig
Jason Zweig became a personal finance columnist for The Wall Street Journal in 2008. Zweig is also the editor of the revised edition of Benjamin Graham’s The Intelligent Investor (HarperCollins, 2003). He is the author of Your Money and Your Brain (Simon & Schuster, 2007), one of the first books to explore the neuroscience of investing, and The Devil’s Financial Dictionary (PublicAffairs, 2015), a satirical glossary of Wall Street.
Before joining The Wall Street Journal, Zweig was a senior writer for Money magazine and a guest columnist for Time magazine and cnn.com. From 1987 to 1995, Zweig was the mutual funds editor at Forbes. Earlier, he had been a reporter-researcher for the Economy & Business section of Time and an editorial assistant at Africa Report, a bimonthly journal. Zweig has a B.A. from Columbia College, where he was awarded a John Jay National Scholarship.
A frequent commentator on television and radio, Zweig is also a popular public speaker who has addressed the American Association of Individual Investors, the Aspen Institute, the CFA Institute, the Morningstar Investment Conference, and university audiences at Harvard, Stanford, and Oxford.
Zweig was for many years a trustee of the Museum of American Finance, an affiliate of the Smithsonian Institution. He serves on the editorial boards of Financial History magazine and The Journal of Behavioral Finance.
‘What You Should Remember About the Markets’ by Gary Antonacci
Because I have been an investment professional for more than 40 years, I sometimes get asked my opinion about the markets. These questions usually come from those without a systematic approach toward investing. Here are some typical questions and answers:
Question: How much do you think the stock market can drop?
Response: 89%.
Question: What?!!
Response: Well, that is the most it has dropped in the past. But past performance is no assurance of future success, so I guess it could go down more than that.
Question: I just looked at my account, and it is down. What should I do?
Response: Stop looking at your account.
Question: What are you doing now?
Response: What I always do… following my models.
After these responses, I am usually not asked any more questions.
Simple But Not Easy
Some say investing is simple, but not easy. This is due to myopic loss aversion. This combines loss aversion, where we regret losses almost twice as much as we appreciate gains, with the tendency to look at our investments too frequently.
We should remember that we cannot control the returns that the markets give us, but we can control what risks we are willing to accept. If we do not have systematic investment rules, it is easy to succumb to emotions that cause us to buy and sell at inappropriate times. The Dalbar and other studies show that investors generally make terrible timing decisions. The most common mistake investors make is to pull the plug on their investments, often at the worst possible time.
But investing does not have to be difficult if we have firm rules in place to keep us in tune with market forces. A sailor cannot control the wind, but she can determine how to take advantage of it to get her where she wants to go.
Trend Following
I have found the most important principle to keep in mind is the old adage “the trend is your friend.” As some say, “the easiest way to ride a horse is in the direction it is headed.” To remind me of how important it is to stay in tune with the long-term trend of the markets, I have this on my office wall:
Source: Quotatium.com
Many are familiar with that saying, but few have the ability to always adhere to it. Much of Warren Buffett’s success is because he had the vision to stick with his approach over the long run. Buffett said, “You don’t have to be smarter than the rest. You have to be more disciplined than the rest.” This discipline applies not only to staying with your positions. It also means re-entering the markets when your approach calls for it, even though uncertainties may still exist.
What gives me the ability to stay with the long-term trend of the markets? First is knowing how well trend following has performed in the past.
Absolute Momentum
There are different approaches to trend following, such as moving averages, charting patterns, or other technical indicators. The trend following method I prefer is absolute (time-series) momentum. It has some advantages over other forms of trend following. First, it is easy to understand and to back test. It looks at whether or not the market has gone up or down over your look back period.
In my research going back to 1927, absolute momentum had 30% fewer trades than comparable moving average signals. From 1971 through 2015, our Global Equities Momentum (GEM) dual momentum model had ten absolute momentum trades that exited the stock market and had to reenter within a three-month period. A ten-month moving average had 20 such exits and reentries. The popular 200-day moving average had even more signals. Fewer trades mean lower frictional costs and fewer whipsaw losses.
You do not need to enter and exit right at market tops and bottoms to do well. In fact, if your investment approach is overly sensitive to price change and tries to enter and exit too close to tops and bottoms, you will often get whipsawed.
Because of whipsaw losses and lagging entry signals, trend following often underperforms buy-and-hold during bull markets. This is the price you pay for the protection you get from severe bear market risk exposure.
But since absolute momentum has a low number of whipsaw losses, the relative momentum part of dual momentum can put us ahead in bull markets over the long run. Absolute momentum can then do its job by keeping us largely out of harm’s way during bear markets. The tables below show how absolute momentum, relative momentum, and dual momentum (GEM) have performed during bull and bear markets since 1971.
Bull and Bear Market Performance January 1971–December 2015
| Bull Markets | S&P 500 | Absolute Momentum | GEM |
| Jan 71–Dec 72 | 36.0 | 32.6 | 65.6 |
| Oct 74–Nov 80 | 198.3 | 91.6 | 103.3 |
| Aug 82–Aug 87 | 279.7 | 246.3 | 569.2 |
| Dec 87–Aug 00 | 816.6 | 728.4 | 730.5 |
| Oct 02–Oct 07 | 108.3 | 72.4 | 181.6 |
| Mar 09–Jul 15 | 227.7 | 136.8 | 106.4 |
| Average | 277.7 | 218.1 | 292.7 |
| Bear Markets | S&P 500 | Relative Momentum | GEM |
| Jan 73–Sep 74 | −42.6 | −35.6 | 15.1 |
| Dec 80–Jul 82 | −16.5 | −16.9 | 16.0 |
| Sep 87–Nov 87 | −29.6 | −15.1 | −15.1 |
| Sep 00–Sep 02 | −44.7 | −43.4 | 14.9 |
| Nov 07–Feb 09 | −50.9 | −54.6 | −13.1 |
| Average | −36.9 | −33.1 | 3.6 |