When one of our clients–a financial advisor–recently presented a relative strength strategy to one of their clients, the client’s response was enlightening. “So, relative strength investing is basically like crowdsourcing, right?” As the advisor thought about it, the similarities were striking.
Crowdsourcing, a business term coined in 2006, continues to gain traction as a way to obtain desired ideas or services by soliciting contributions from large groups of people rather than by a smaller group of employees. From Wikipedia, to genealogy research, to KickStarter and beyond, people and institutions are becoming aware of the benefits of engaging the masses. Take Wikipedia as an example of the benefits of crowdsourcing. Encyclopedias aimed to convey the accumulated knowledge of experts on a broad range of subjects. They were a great resource for sure, but quickly became outdated and were often limited in scope. Enter Wikipedia, launched in 2001. In contrast to the experts that were engaged to compile the information for encyclopedias, Wikipedia, at least originally, was open to anyone to create articles on any topic (now only registered users can make contributions). Obviously, many of those contributors to Wikipedia were far from experts on the topic that they were writing about. However, errors were relatively quickly corrected. Today, Wikipedia has over 38 million articles in over 250 languages—massively larger than any set of encyclopedias. Wikipedia is a giant leap forward, and is based on the “wisdom of the crowds.” The masses over a relatively smaller group of experts.
It is probably obvious why this person made the connection between crowdsourcing and relative strength investing. Relative strength calculations are derived from prices of securities. Those prices are simply the equilibrium point of aggregate supply and demand activity in the market. In a very real sense, prices include the market activity of every market participant in that security. This stands in stark contrast to typical investment management firm that has an investment committee comprised of a team of portfolio managers and analysts. This sample investment management firm may see it as their objective to identify securities that they deem to be worth more than its current market price. In other words, their objective is to identify opportunities where the market is wrong and they are right. They are relying on a panel of experts whereas a relative strength approach engages the masses. A relative strength approach to investing doesn’t “argue” with the current market price. It simply accepts it for what it is and then sorts a universe of securities by their momentum versus a broad market benchmark or versus the momentum of its peers.
Why limit yourself when making buy and sell decisions to a small group of people, even if those people are “experts,” when you can benefit from the wisdom of the crowd?
The relative strength strategy is NOT a guarantee. There may be times when all investments are unfavorable and depreciate in value. Image source: www.blog.sermo.com