One of the ongoing difficulties for investors is finding some kind of simple method for investing. Relative strength is just such a simple method. Even simple methods, however, have to be applied!
Tadas Viskanta from Abnormal Returns writes:
…having a plan, even a sub-optimal one, that you can stick to is preferable to having no plan at all. The ongoing challenge for advisors and investors alike is to find a plan that they will not abandon at the first sign of trouble.
That’s an important point. If you can’t follow a method because it is too complex and if you bail in panic during the first downturn, you’re not going to succeed with any method.
Abnormal Returns revisited this theme recently, in connection with a discussion about systems versus optimization. Mr. Viskanta pulled a quote from Scott Adams:
Optimizing is often the strategy of people who have specific goals and feel the need to do everything in their power to achieve them. Simplifying is generally the strategy of people who view the world in terms of systems. The best systems are simple, and for good reason. Complicated systems have more opportunities for failure. Human nature is such that we’re good at following simple systems and not so good at following complicated systems.
This has a great deal of applicability to the investing process. Simple systems are generally more robust than complex systems, and relative strength is about as simple as you can get. Relative strength is not an optimized system—like most simple systems, it will make plenty of mistakes but its simplicity makes it robust. (I would note that Modern Portfolio Theory relies on mean variance optimization to construct the “ideal” portfolio. Optimized systems are both complicated and fragile.)
In practice, complicated systems tend to blow up. Robust systems are generally more resilient to failure, but will certainly struggle from time to time.
Human nature, I think, makes it difficult to follow any system, whether simple or complex, so discipline is also required. Investors will improve their chances for success with a simple, robust methodology and the discipline to stick with it.