The YouTube video by Veritasium below shows people’s scepticism of an edge when viewed by itself. However, the effect of an edge when compounded and repeated indefinitely is, as Albert Einstein said, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Yearly Highs versus Yearly Lows on the Market
Empirical evidence suggests that a stock in downward trend has a higher probability of continuing in a downward trend than reversing and trending higher.
Testing this theory, all current and delisted stocks on the ASX were backtested as they made a new yearly low and as they made a new yearly high.
The probability of a stock making a yearly low and continuing to trend lower is greater than 50% over the next 12 months. However, the probability of a stock making a yearly high and continuing to trend higher increases from 53% after a month to 60% after 12 months. The edge in buying a stock trending up over one that is trending down is greater than 10% after 12 months. In summary, there is an edge in buying stock strength.
Simulating this edge using a simple equal weighted portfolio, buying ASX stocks making yearly highs between 1997 and 2011, produces compounded annual returns of 18% with a drawdown of 50% (compare to the ASX All Ordinaries Index producing compounded annual returns of nearly 9% with a similar drawdown of 51%).