According to many financial economists, the answer is a resounding, "NO." It’s just not possible.
However, true to form … I strongly disagree. Let me explain…
Efficient-Market Hypothesis (EMH)
Many academics believe in the theory that markets are efficient. This means there are neither real bargains nor any over-priced stocks. Share prices are “fully baked” in the market since all available information has been assessed and included.
Theoretically … there can be no variation on value as a stock’s future prospects are already factored into the price. Therefore the market price reflects the correct value of the stock.
But you may be thinking … correct compared to what?
Correct when you consider the ratio of risk/reward when compared to all other stocks in the market. Therefore, over long periods of time, stocks should deliver similar returns when adjusted for risk.
And if this is the case. Trading stocks with high potential rewards and higher risk would achieve similar gains to the trading of a large basket of defensive utilities.
In a nutshell, it should be virtually impossible for any investor to consistently beat the market average – regardless of trading high or low risk stocks.
Over time, solid due diligence would have no difference over blindly throwing a dart at stock tickers on a board—the returns should be the same.
While all this sounds rational—perhaps from an economist’s “white tower” perspective—my experience of the market begs to differ. The Studies Don’t Lie!
Take for instance those investors who consistently outperform or underperform the market. This would have to cast doubt on the efficient market hypothesis.
Given enough time and trades, ALL investors should be trading similar to a common benchmark or index.
This assumption was put to the test in a 2005 paper, Can Individual Investors Beat the Market? And it’ truly interesting what they discovered. The top 10 percent of investors consistently outperformed the bottom 10 percent of investors by an average of 8 percent annually.
OK, big deal. My initial reaction was that they were simply stating the obvious. But then I took a deeper look. If EMH is true, investors should NOT be able to consistently outperform the market or even underperform the market ... over time.
And other papers report on the persistent gains and outperformance of hedge funds with various market beating strategies. Even literature regarding the use of a simple moving average to remove many outlying events from your trading (days of extreme movement) reduce volatility and increase average returns (Decoding Black Swan: A Quantitative Approach to Tactical Stock Investing).
I could go on with study after study which brings into question the most basic of market theories.
Even the concept that stocks with higher risk have a ‘risk premium’—which means you get a higher than average reward for trading riskier assets—becomes a bit absurd. If this were so, wouldn’t it stand to reason that a broad portfolio of riskier assets would always beat a broad portfolio of less risky assets?
So why the added risk if you could theoretically buy an ETF full of risky assets and just beat the market?
Stubborn Sentiment is Not Efficient Pricing
For these reasons and many more, the Portfolio Café team believes that the market is NOT efficient. And there is NO omnipotent force creating an equalized risk/reward scenario for every stock.
It’s more likely that there is an ability to forecast price and market movements—although it neither easy nor quick to do. If it were … you could simply buy a stock and yell from the rooftop that it is underpriced and expect investors to come running.
Sentiment is as stubborn as an old mule. But that doesn’t mean it’s always correct. I’ve seen companies trading at a fraction of the cash they have in their bank accounts vaults—assailing any logic whatsoever. Yet, investors will not drive the price up.
So what can you do ... and how can you profit?
Portfolio Café Beats the Market
Here are methods at the Portfolio Café that you can use to beat the market …
- The first objective is to minimize risk. The Café does this through market timing techniques that recommend hedging or going to cash when a bull market ends.
The Café analyzes various factors including sentiment, forecast earnings, valuation and price trends. And by taking steps to avoid ‘black swans’ … in addition to trading with the trend … your risk-adjusted return can increase.
- The second objective is back-tested mechanical trading strategies. The Café uses this to isolate opportunities with high profit potential and reasonable valuations.These opportunities range from large defensive utilities to small-cap high-growth firms. And each strategy is carefully thought out as to WHY the trading rules will identify superior companies going forward instead of simple filtering based on what worked in the past.
One example is the trading of a basket of 10 to 15 hand-picked stocks during bull markets with frequent rebalancing—showing investors what it takes to beat the market.
Are you willing to take the 30-day risk-free trial to discover new profits? If the EMH is true you have nothing to lose. But if strategy trumps ‘dart board investing’, you only have your financial future to gain.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer