SCOTT WELSH TRADING BLOG

How To Beat The Market In Times Of Chaos

How To Beat The Market In Times Of Chaos

October 19th, 2018

The stock market made some news last week.

The news this week hasn’t been that great, either.

There have been big market drops on multiple days and that brought out the doomsayers.

We haven’t had a real bear market since 2008. We warned you it was coming and now it’s here!

Maybe. Maybe not.

But it’s always best to hope for the best and plan for the worst–which got me thinking.

What kind of system beats the market in chaos?

Assuming this is the beginning of a correction (or worse), what can we do to make money?

During the Great Margin Call, the worst of the worst came at the end of 2008 and the very beginning of 2009. So that’s the period I’m interested in. What system works well from that time of chaos to now?

The first thought to come to mind is value investing. If you want a strategy that works well in tough times, value investing might be one of the best. Value investing looks for valuable things at cheap prices and cheap prices are everywhere during chaos. While value investing tends to struggle more in high-flying times, it is a great way to trade when times get negative.

So what’s the strategy?

As you know, I like simple systems, and the simplest value investing system I’ve found is to use “Magic Formula” stocks. Magic Formula stocks, of course, are stocks that have good fundamentals but are trading at cheap prices. You can learn about this in detail in Joel Greenblatt’s great book The Little Book That Still Beats the Market.

But if you don’t know or don’t care about Greenblatt’s methodology, here’s what you can do. You just go to the Magic Formula website and run the free scan. And that’s exactly what I did back in 2008. I wasn’t trading stocks in that scary time but I was tracking stocks. And I knew that it was a historic time and I wanted a record of what was happening.

As a result, I have an actual list of magic formula stocks that I ran in real time during the crisis of 2008-2009.

And here’s how it did.

First, keep in mind that I had a list of 27 magic formula stocks and not all of them are still trading today. One basically went bankrupt and a few others were bought by other companies and/or went private. Those companies who aren’t still around did not factor in to the final tally. Some were big winners and some were decent winners and some were losers. It’s reasonable to say that it wouldn’t have changed our results materially.

Second, keep in mind that the “market” has returned about 15% per year (Compounded Annual Growth Rate). We’re looking to beat the number if we can.

Last, I hypothetically assumed I had a $30,000 portfolio and bought equal amounts of each magic formula stock. I didn’t re-balance or anything. I just bought and held every stock until now (or until it stopped trading).

Using a nice tool that was referred to me by a friendly emailer, it’s possible to see how the magic formula stocks performed compared to the market. Here are the results:

The magic formula portfolio outperformed the market (as depicted by a Vanguard Index Fund) by 4% per year. In dollar terms, the magic formula would have put $53,000 more into our pockets. That’s pretty substantial.

As we thought, using a simple value investing system in times of chaos can pay dividends. Well, maybe not literally pay dividends, but you know what I mean.

Value investing can be a powerful method in times when the market is getting crushed. And picking value stocks from a simple free scan is about as easy as it gets. If we are embarking on a correction, this might be something to strongly consider.

But that’s not the only method we could use during chaos. We’ll look at other ways to try to beat the market in emails to come later this week.

To see the weekly YouTube video, go here.

 

Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.