How do you rate an NBA team across a decade of play? One method is “Elo,” a simple measure of strength calculated by game-by-game results (Source: Nate Silver’s FiveThirtyEight). A description of Elo is below:
Elo ratings have a simple formula; the only inputs are the final score of each game, and where and when it was played. Teams always gain Elo points for winning. But they get more credit for upset victories and for winning by larger margins. Elo ratings are zero-sum, however. When the Houston Rockets gained 49 Elo points by winning the final three games of their Western Conference semifinal during this year’s playoffs, that meant the Los Angeles Clippers lost 49 Elo points.
A rating of 1500 is approximately average, although the league average can be slightly higher or lower depending on how recently the league has expanded. (Expansion teams begin with a 1300 rating.)
As Nate Silver recently tweeted: “Last time the Spurs were a below-average team was in Jan. 1998, right about when the Lewinsky scandal was breaking.”
Impressive, is it not? Talk about an organization that figured out a formula for sustained success. On the opposite end of the spectrum, consider the Elo of the Clippers as shown below:
Yes, they have become an above average team in recent years, but man did they stink for the better part of the last several decades!
What stands out to me in flipping through the Elo of the different NBA teams is the outliers. Yes, there are a lot of teams that hover around average, but there are some stark standouts.
How true this is in the financial markets as well. In fact, this reminded me of a study completed by BlackStar Funds a couple years ago when they looked at the lifetime total returns of individual stocks relative to the corresponding return for the Russell 3000. Again, what stands out to me is the outliers. 6.1% of all stocks outperformed the Russell 300 by at least 500% during their lifetime. Likewise, 3.9% of all stocks lagged the Russell 3000 by at least 500%.
Outliers are what makes this business fun and ultimately where the most money can be made. Just like with certain NBA franchises, there are multi-year winners and multi-year losers in the financial markets. Relative strength, much like Elo, can help you stay on the right side of those trends.
The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.
