Salil Mehta is a statistician and risk strategist. He served for two years as Director of Analytics in the U. Salil is on the Editorial Board for the American Statistical Association, is a Chartered Financial Analyst, a fellow member of the American Statistical Association and Royal Statistical Society, as well as being a current dual candidate member of the Society of Actuaries.

Look at these four anonymized stocks below, each trading from the mids.

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What do you see in each of these stocks? Are there some hints in each of them, which indicate that one of the two trading strategies is better? Are stocks A and C better buys, versus stock D? And what sort of returns would you get from just these simple trading rules described here? By answering such math questions, we learn a lot about the risks and rewards, of these fundamentally exclusive trading ideas.

Pause for a moment and try to determine by looking at the four stock returns above, which sort of trading signal and profile would be generated:. Inspecting the above stock chart more closely, we might also notice that both trading signals only worked about 7 or 8 of the years, per company or a quarter of the time. This also implies nearly half of the time neither trading style exclusively applied, even though the stocks were in an overall uptrend.

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We also notice that fairly equal returns from stocks A and C, have differing results within the same strategies! Both can suffer losses from mistiming still. Putting this altogether, we see all of the mixed prospects of using one of these trading strategies. This is likely less than any optimistic market participant would have guessed a-priori e.

Still not convinced buy-and-hold would be the best approach to these stocks above? Think there is a better rule-based algorithm you could apply to better tune your approach to each of these four stocks? The stock chart above is bogus , and in fact each series is just a random number generator. See the de-trended chart below.

Whatever happens in any given year has no influence on what happens the following year. And the key probability insight for this article is: One is essentially being fooled. Instead volatility fell and we are now yet again at all-time highs, including the once-bubbled Nasdaq. A legendary portfolio manager, who self-terminated his portfolio management career after a nice run, said of those who try timing the market: Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.

You use moving averages to manage risk exposure, yes? I think I heard you mention that on the Bill Gross interview.

How Greed and Easy Money Corrupted Wall Street and Shook the World Economy Learn More Mean Reversion February 28, Pause for a moment and try to determine by looking at the four stock returns above, which sort of trading signal and profile would be generated: Discussions found on the web: So this essay has nothing to say about trading actual stocks. May 18, A Face in Numbers: Bank of England to Posted Under Investing Mathematics Research. Previous Post 10 Weekend Reads. Joe Saluzzi of Themis Trading.

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