Fact: most professional traders, investors, and hedge funds can barely beat Buy and Hold. Don’t Buy and Hold. Buy and Wait. Those who Buy and Wait will massively outperform professional traders and those who Buy and Hold in the long run.
Outperforming the average trader and investor over the long run isn’t hard. It’s just a matter of knowing what to do.
- Trading and investing is about probability. Use probability to your advantage. Don’t “guess” what the market will do. We show you these probabilities in the Membership Program.
- Traders and investors who combine fundamental data with technical data will outperform traders who solely use fundamental or technical data over the long run.
- Simple quantitative trading models allow traders to backtest their strategies and know EXACTLY how well a strategy works.
Why you should trade index ETFs instead of individual stocks
Trading the index (e.g. S&P 500) via ETFs (e.g. $SPY, $SSO, $UPRO) is much easier than trading individual stocks.
- Traders who trade individual stocks have to care about what the broad stock market index is doing. Most stocks will go up during broad equity bull markets, regardless of the individual stock’s fundamentals. Most stocks will go down during broad equity bear markets, regardless of the individual stock’s technicals.
- Traders who trade the index don’t have to care about what individual stocks do. No single stock is big enough to have a significant impact on the broad index in the medium-long term.
Why you should trade for the medium-long term instead of the short term
The short term is harder to predict because there is a lot of randomness in the market’s short term movements. The stock market’s medium-long term is much easier to predict because it follows the fundamentals of the stock market (i.e. economy).
Why you should focus on the economic data when trading the stock market
The U.S. stock market and the U.S. economy move in the same direction in the medium-long term. This is inherently logical. The economy drives corporate earnings, which drives stock prices.
This chart demonstrates that the stock market rarely makes big declines outside of recessions.
*The Wilshire 5000 is an index of all active stocks in the U.S. stock market, which makes it broader than the S&P 500.
Short term deviations between the stock market and economy are technical in nature. Some of these deviations can be predicted through technical studies. If the stock market and economy start to move in opposite directions, the stock market will eventually move in the same direction as the economy.
Some people say that “the stock market leads the economy”, while others say that “the economy leads the stock market”. Both of these camps are right, but each camp is only telling you 1 half of the story.
The stock market leads the “economy”, as defined by GDP. The stock market tops before recessions begin. However, GDP is a lagging economic indicator.
- Certain LEADING economic indicators lead both the stock market and the economy.
- So the chain of events look like this. Leading economic indicators (e.g. housing indicators) start to deteriorate. Then the stock market tops. Then GDP turns negative (a recession).
That’s why we focus on leading economic indicators here on the blog to predict the stock market’s medium-long term. The leading economic indicators will start to turn before the stock market makes long term tops and long term bottoms.
We look at technical studies to predict the stock market’s short term.
Also, it’s important to remember that economic expansions and equity bull markets DO NOT die of old age. How long a bull market and economic expansion lasts depends on the country’s individual circumstances at the time.
Our quantitative models for trading the stock market
I have developed quantitative trading models for trading the U.S. stock market. None of these models are extremely complex. In a way, “simplicity is the ultimate sophistication”. There is no need to throw in a hundred different indicators to build a trading model that outperforms in the long run.
The Medium-Long Term Model is my most complicated model and generates an average of 43% per year (backtested over the past 50+ years).
I have other much simpler models that generate 10-20% per year. These simple models clearly outperform the S&P 500 in the long run, which generates an average of 7-8% per year.
Armed with my simple set of models, an average investor or trader can easily outperform the gains offered by most professional traders and funds who make most of their money through service fees rather than money management.
Why we don’t use forward earnings to predict the stock market
Forward earnings = analysts’ estimates for companies 12 month future earnings. These estimates tend to be accurate as long as the economic expansion continues. These estimates tend to be wrong when a recession begins.
This is why forward earnings tend to lead 12 month trailing earnings. The exception occurs near the start of recessions, when forward earnings lag 12 month trailing earnings. This makes sense: the job of an analyst isn’t to predict recessions.
Hence, forward earnings are wrong precisely when you need them the most: during bull-bear transitions. That’s why you must use economic data instead of forward earnings data to predict bull-bear transitions.