By Jonathan Burton, MarketWatch
SAN FRANCISCO (MarketWatch) — "Buy high, sell higher" seems an
appropriate strategy only for the bravest investors, but buying
what's hot and letting these winners ride isn't as risky as it
sounds.
Stock market winners tend to repeat — over the short-term. Buying
the top three U.S. market sectors of one year and holding them through
the following year has solidly outperformed the benchmark Standard &
Poor's 500-stock index
/quotes/comstock/21z!i1:in\x
(SPX
*1,293*,
+9.48,
+0.74%)
most of the time over the past two
decades, with only a bit more volatility, according to Standard &
Poor's Equity Research.
!! Day Trading Doesn't Pay !!
James Altucher says day trading will likely result in lost money
and bad habits. Dow Jones Wealth Adviser's Veronica Dagher reports.
This momentum-driven strategy, akin to the "hot hand" or "follow
the leader" theory, currently points to more gains for the
market's three most-popular sectors: consumer discretionary, up
25.1% this year through Dec. 8; industrials, up 20.3%, and materials,
with a 13.6% gain. The S&P 500 added 10.1% over the same period. All
returns exclude reinvested dividends.
Here's how you let your winners ride: Buy 2010's three best S&P
500 sectors before year-end and hold them until the end of 2011. Then
sell that group, buy whatever sectors do best next year, and own those
winners through 2012. Repeat the process each year.
The strategy has an impressive track record. The three sector winners
produced a 10.3% average annualized gain, excluding dividends, from
the end of 1990 through Dec. 8, S&P found. That beat a portfolio of
the three sector losers, which rose 8.9% annualized over the same
period. Meanwhile, the S&P 500 was up 8.6%. The sector winners carried
slightly more risk, but their extra return compensated for the bumps.
"You're much better off sticking with the winners than you are
with the losers on a one-year basis," said Sam Stovall, chief
investment strategist at S&P Equity Research. Indeed, "let your
winners ride" is the first pointer Stovall outlines in his book,
"The Seven Rules of Wall Street."
!! Follow The Herd!!
This long-only price momentum strategy isn't new, but it might make
you uncomfortable. Momentum investing flies in the face of the
long-term oriented advice that individual investors typically hear.
Conventional advice eviscerates hot-hand investing as little more than
gambling and market-timing, and to be sure, momentum strategies can
fail miserably. For example, the three best sectors of 1999 tumbled
26.5% in 2000 while the S&P 500 lost 10.1%, according to S&P.
Letting your winners ride also fell short in 2009, when the three 2008
winners gained 11.7% versus 23.5% for the S&P 500, according to S&P.
The winning sectors also trailed slightly in 2003 and 2004.
That's the painful, dark side of momentum investing: Nobody knows
when the music will end. So be careful. Letting your winners ride is a
short-term play — no more than 12 months — that requires a high
level of discipline and progressively higher stop-loss orders to
protect your gains.
Yet on a year-by-year basis, the odds favor momentum buyers. The
portfolio of the three top S&P 500 sectors has beaten the benchmark
70% of the time over the past two decades, S&P found, versus a 40%
success rate for the bottom three.
Advisers also warn against throwing money at what's hot. But in fact
you might not be too late to the party.
"Identifying the leading S&P sectors and expecting the ones that did
best over the previous period to continue to outperform has been a
profitable strategy," said Marvin Appel, editor of Systems &
Forecasts, an investing newsletter.
!!Everybody Loves A Winner!!
Those years when sector winners stumbled offer clues about when and
why momentum investing fails.
Momentum strategies need market sentiment to move in an upward
direction for an extended period. At such times, volatility is low
and, as another Wall Street maxim teaches, the trend is your friend.
Source: Marketwatch.Com
