Phil Jackson’s 11 Mindful Leadership Principles are worth studying. I am always happy to learn from someone who has achieved greatness and 11 NBA titles would certainly qualify! Number 10 has particular relevance to investors, especially investors who are employing relative strength:
10. When in Doubt, Do Nothing. ”Basketball is an action sport, and most people involved in it are high-energy individuals who love to do something—anything—to solve problems. However, there are occasions when the best solution is to do absolutely nothing….I subscribe to the philosophy of the late Satchel Paige, who said, ‘Sometimes I sits and thinks, and sometimes I just sits.’
In the realm of investing, there is a natural tendency to believe that increasing the frequency of trading will lead to better results. Testing shows that not to be the case. Consider the following excerpts from Point and Figure Relative Strength Box Sizes by John Lewis.
Point and figure charts use box sizes to control the volatility of the chart. A large box size filters out more short term movements than a smaller box size. As a result, a chart with a small box size can have many more columns than the same chart with a larger box size. The goal is to find a box size that is small enough to pick up the intermediate term trend, but large enough to filter out the short term trading gyrations that lead to whipsaws… …So what box size should you use? The data in Table 1 summarizes a strategy that buys stocks with strong relative strength characteristics… …The universe is comprised of the top 1,000 U.S. stocks by market capitalization. We include companies that have been delisted for any reason. Each month a point and figure relative strength is calculated. As we demonstrated in our previous study, those stocks having the best momentum characteristics (on a point and figure “buy” signal and in a column of “x’s”) performed the best over time. For the original study we used a 6.5% box size for equities versus a broad market benchmark, which is the default box size for equities on the Dorsey, Wright research database. We now extend that study by calculating point and figure relative strength charts for each stock using box sizes ranging from 1.5% all the way up to 10.5% at 1.0% intervals. Each month the average equal weighted return for the group of stocks on point and figure buy signals and in a column of x’s is calculated. All of the stocks are held for one month and then the group is reconstituted and reweighted.
The data in Table 1 helps us determine what the equivalent of an intermediate term horizon is in terms of point and figure boxes sizes. Much like the time-based methods, the returns suffer when the box size is too small or too large. In the case of the former, the system picks up too much of the short term trading noise.In the case of the latter, too much has to happen in order for the point and figure chart to register a change. The sweet spot is in the 6.5% to 7.5% box size reange. Using a 6.5% box size means that a security has to underperform the broad market by 19.5% in order to change columns and be shifted out of the group that qualifies as having the best relative strength.
My emphasis added. In other words, using a smaller box size certainly leads to more trades (which can make investors feel better about themselves), but better investment performance has come from slowing the signals down in order to avoid “trading the noise.”
Yes, investing is an action sport, just like basketball. Phil Jackson was notorious for not calling time out in the final minutes of a game and the results were favorable. Similarly, when employing a relative strength strategy it can be advantageous to stay the course, only making changes when the longer-term relative signals suggest that change is warranted.
The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.
HT: Michael Covel
