Buying stocks that exhibit a patterns of an upward trend is a worthwhile pursuit of anyone who has money in the stock market. Allocating a portion of your portfolio to such stocks can bring big rewards.
Eric Crittenden and Cole Wilcox of Blackstone Funds did extensive research of the Russell 3000 to determine whether trend following worked on stocks. As mentioned in their report, the Russell 3000 represents approximately 98% of the investable U.S. equity market. They analyzed the period from 1983 to 2006.
While their report contains lots of important data, two key statistics stand out:
*64% of all stocks underperformed the Russell 3000
*25% of all stocks accounted for ALL of the Russell 3000 gains
This report has important implications for anyone investing in mutual funds, index funds or any investment vehicle designed to replicate the performance of the overall market. All such investments encompass the good, the bad and the ugly of equity markets – i.e., mediocrity.
Clearly the challenge for all equity investors is to attempt to discover those stocks that account for 25% of all market gains.
The methodology proposed by Crittenden and Wilcox in an effort to capture the 25% of winning stocks is to invest in stocks that hit historic highs. For detailed results of the trading system that was inspired by this research see their paper, “Does trend following work on stocks?”
The answer to that last question is an absolute “Yes.”
Which begs the question: Why not use the trading system that was the basis for the Crittenden/Wilcox analysis?
The Big Bet Stocks systematic screens are capable of capturing stocks hitting historic highs and subsequently building profitable trends. They are also capable of capturing stocks that have been beaten down – either because of internal fundamentals or external market conditions – that subsequently build profitable trends. The historic high concept, by definition, is not capable of capturing those latter trends.
Big Bet Stocks uses two sources of data to identify stocks with the potential to perform within the top 25% of all stocks – Institutional Investments and Unusual Volume.
The logic supporting the Institutional Investor metric is this: These are some of the nation’s most experienced investors with unmatched resources for discovering tomorrow’s winning stocks.
The logic supporting the unusual volume metric is this: When stocks experience a significant increase in volume and also close at a higher price vis-à-vis the previous day’s close, investors have uncovered compelling information to become aggressive buyers of that stock.
The Institutional Investor and Unusual Volume data sources are carefully screened to identify stocks that offer the potential to trend higher. On an annualized basis there are typically have a universe of roughly 1,000 stocks. Every day the closing prices of all those stocks are recorded and gains or losses are measured vis-à-vis previous closing prices.
By identifying stocks with meaningful and repetitive daily and weekly percentage increases in closing prices, it is possible to capture stocks that offer the potential to evolve into significant upward trends.