You Can Beat the Market? A Study Says 1 in 5 Can

Discussion in 'Trading' started by trader99, Mar 16, 2003.

  1. trader99


    Perhaps it's not all hopeless! 1 in 5 is 20%. Not as bad as the 90-95% losers in daytrading..


    You Can Beat the Market? A Study Says 1 in 5 Can

    A NEW study has found that as many as 20 percent of investors may be able to regularly pick stocks that beat the market.

    Most previous studies have emphasized the inability of the average investor to outperform stocks in general, though some researchers have conceded that some people can do so over a given period — sometimes, for many years. Still, researchers have generally assumed that the percentage of investors who can do this consistently is very small.


    The new study, however, has found that assumption to be wrong. It was conducted by three finance professors — Joshua D. Coval of the Harvard Business School, David A. Hirshleifer of Ohio State University and Tyler G. Shumway of the University of Michigan — and has been circulating since January as an academic working paper (

    The professors reached their conclusion after examining a database containing the complete trading histories of more than 110,000 individual accounts at a national discount brokerage firm. (The professors would not disclose the name of the firm; they did say that the names of the account holders were not included in the database.) The database covered trading from the beginning of 1990 through November 1996.

    But don't some investors beat the market through luck alone? To deal with that possibility, the professors conducted a series of statistical tests. They were less interested in investors whose cumulative performance beat the market, because chance can play a large role over such a period. Instead, they looked for those whose stock picks repeatedly surpassed the market average.

    The study focused on nearly 17,000 accounts in which investors had bought at least 25 stocks — an amount large enough to give the researchers confidence that any outperformance was not a result of mere chance. The findings were also adjusted for risk, to ensure that investors had not beaten the market simply by taking on greater risk in a period when stocks generally were rising. After considering these factors, the professors found that about one-fifth of these frequent traders had genuine stock-picking ability. In that group, the average stock gained 44 percent a year, annualized, over this period, versus 14.5 percent for the Wilshire 5000.

    The professors saw little evidence of stock-picking ability among most of the other investors. Though their average stock slightly beat the market, the professors found that the margin of outperformance was not enough to pay commissions and bid-asked spreads. In other words, a large majority of investors would still be better off investing in an index fund.

    About 10 percent of the active traders stood out because their stock picks consistently underperformed the market — reflecting what the professors called "negative ability." The average stock picked by this group lost 23 percent, annualized. These traders clearly would improve their returns by investing in an index fund.

    HOW can the research help you know if you are part of the elite stock-picking group — that top 20 percent — and whether you should keep choosing your own stocks? That is difficult, because the study used complex statistical tests to determine genuine ability.

    But Professor Coval suggests this test, while not perfect, offers at least a tentative answer: First, compare each of your 25 most recent stock picks to its appropriate index, being careful to find a benchmark that matches its market capitalization and value or growth characteristics. If you find that at least 18 of those 25 stocks have outperformed their benchmarks over the time you have held them — and that the 25 stocks' average return beats that of their benchmarks — you probably have what it takes to beat the market.
  2. Beating the market doesn't necessarily mean making positive returns :)

    You are comparing two very different statistics... and another thing... I wonder is the study was implemented across positions taken and held, irrespective of whether sensible stop losses were taken out... my view is that the study has some major methodological problems...

    20% is way too high... 1 in 20 (5%) is about right and is in line with most businesses...
  3. trader99


    Yeah, I'm aware of that. I used to be in both relative and absolute performance crowd and I do know the difference. However, I guess I'm wrong to make an implicit assumption that the sHBS tudy classified people who beat themarket by they making money as well. But ASSUMPTIOn is a dangerous thing... Well, would need to read the actual paper to tell.

    I mean in relative performance sense, anyone who had a stop loss in would have beat themarket the last 3yrs. haha! LOL
  4. yabz


    Their study only contains 6 years worth of data, which is maybe not long enough to flush out all the risk characteristics of the investors' trading style.

    Studies of mutual funds have shown that a small number of managers can consistently beat the market for around 5 years after which they start losing, sometimes dramatically.

    I would guess that at least 10 or 12 years worth of data would be needed to draw the conclusion of their paper.
  5. trader99



    true. true. Too small of a sample size. You all are beginning to talk like efficient markets academics. lol. Been there done that.

    Anyhow, however, it's true. If you go far enough in time, then it seems like hardly ANYONE can consistently beat the market. But given any random sampling of time period, it seems like some can beat it handsomely..
  6. it could be interesting to see if these outperformers have been able to survive in this bear market ...

    I have some doubts that many of them have crash since then!

    If this is the case, the statistic should be a lot lower!
  7. trendy


    Article refers to investors as opposed to traders. Although I don't believe the article mentioned shorting, I assume the accounts they reviewed were not engaged in short selling.
  8. Pabst


    1 in 5 sounds about right for investors vs. the indicies.