Note: This article is courtesy of Iris.xyz
By Amy Kemp, Asset Management Research Specialist, Nasdaq
The ability to efficiently and effectively communicate one’s process to both prospects and clients is arguably the most important piece of an advisor’s skill set. This is something we at Dorsey, Wright & Associates, a Nasdaq Company, can relate to as well, as we are often asked to explain our process and approach to investing.
Providing evidence from third parties can help give credibility to your story. The book, “What Works on Wall Street: The Classic Guide to the Best-Performing Investment Strategies of All Time,” by James O’Shaugnessy, is an excellent such source, especially with regard to relative strength research. While O’Shaugnessy tested and examined many different investment strategies, his findings surrounding relative strength strategies were particularly compelling, and establish evidence for applying it in a systematic fashion, much like we do. There are a few key excerpts from the book we feel can be particularly helpful when the time comes (as it does with every investment philosophy) to defend your process.
Quote #1 – “The only way to beat the market over the long term is to use sensible investment strategies consistently…The lack of discipline devastates long-term performance.”
The ability to make rules-based investment decisions, and to do so in a repeatable fashion, is easier said than done. It becomes far more challenging when the factors that guide your “rules” are ambiguous to begin with. Many fundamental inputs, whether growth or value oriented, can become ambiguous over time. Accounting standards can shift, analysts can focus upon top-line instead of bottom-line numbers, etc. All of us can recall the manner in which “dot-com” companies had their numbers massaged by analysts in an effort to generate a positive opinion as the stocks were rising.
When the stocks began to fall, changing that opinion in a timely fashion was hard to do, since the data supporting the “buy” recommendation didn’t change. If an analyst says to “buy” a company that isn’t making money, the simple observation that they are still not making money a year later doesn’t give cause to downgrade the stock. Market psychology can change much faster than company fundamentals, and this is why price inputs are so useful.
Price is an objective input, and our relative strength calculations are based solely upon price inputs. There is no “pro-forma” relative strength calculation that might be confused with the GAAP relative strength analysis. Relative strength is calculated simply by dividing the price of one security by another on a daily basis, and that calculation comes to life once we plot it on a Point and Figure (PnF) chart. At any time, a PnF chart is either on a buy signal or a sell signal. There is no gray area, allowing the practice of constructing relative strength-based portfolios to be conducted in both a “sensible” and “consistent” manner.