Intuitively, investors feel like the more nimble they are, the better they will do. They put tremendous pressure of themselves to capture every wiggle in the market. Yet, much of the time, going faster is counterproductive.
In this blog post, “Understanding How Markets Move,” noted psychologist and trader Brett Steenbarger uses the simple example of a moving average system applied to the S&P 500. The more you speed up the moving average, the worse it does. That seems counter-intuitive, but you have to keep in mind that trends are what make money and trends are often slow. The faster you go, the more noise you capture, and thus, the worse you do.
We find exactly the same process at work when using relative strength. Reacting to short-term relative strength does not perform well over time. The best-performing models follow intermediate to long-term relative strength—and just tough out the periods that are rocky. Many clients have trouble sitting still when going through a rocky period, but as Steenbarger points out in his post, you have to deal with the asset you’re trading. Stocks have their own time frames for trends and an impatient investor isn’t going to speed it up. If you want to trade financial assets, you have to work with them on their own terms.
