Credit: Shutterstock photoToday I want to tell you about an investing strategy that defies logic. It shouldn't work based on everything we've learned about the stock market.
Yet it does. In fact, for over half a century, investors and traders have used this strategy to produce unparalleled results.
And no, for those of you who may be wondering, this strategy doesn't involve options, derivatives or any other obscure financial product.
What's more, what I'm about to show you can be used as part of any general investing strategy -- regardless of whether you're focusing on income, growth, blue chips, small caps or even commodities.
Specifically, I'm talking about relative-strength investing.
Longtime readers might already be familiar with relative strength investing. We've talked about it before in previous StreetAuthority Daily issues. For those who need a refresher, allow me to provide a brief recap.
Relative-strength investing is simply a type of momentum investing. It involves buying the best-performing stocks (relative to the market) and holding them until their momentum changes course.
To most investors, especially those considered value investors, this strategy probably sounds ridiculous. After all, most people have heard the phrase "buy low, sell high." Since relative-strength investors buy stocks that are already outperforming today, many view this style of investing as counterintuitive.
But that's a mistake... and it's one many people make whenever they approach a stock pick.
That's because most investors have been trained to think the stocks with the most upside potential are those that are the most "undervalued." The definition of undervalued varies by investor, but normally people use metrics like low price-to-earnings ratios, price-to-book ratios or discounted price-to-sales values, just to name a few, to describe it.
The problem is that this kind of approach leads investors to pass up the market's best-performing stocks in favor of the ones doing the worst. Since underperforming investments usually sport the "lowest valuations," we tend to think these stocks are the more attractive buys.
Metaphorically speaking, this is like abandoning a luxury yacht in favor of sailing around the world in a leaky shrimp boat because buying a ticket on the shrimp boat can save you half the cost of your trip. Don't get me wrong, I like saving money, but I'll gladly take the yacht if it means I'm going to enjoy my vacation and get back home alive.
Unfortunately, when it comes to investing, most people don't look at stocks like that. They see a great-performing company with an average or premium valuation (the yacht) as riskier than a stock that is underperforming and has a low valuation (the leaky shrimp boat).
Research has proven that this is a terrible fallacy. It turns out that the best-performing stocks, the ones already beating the market today, are in fact the best investments to own... at least in the medium term.
One of the best studies on this phenomenon was done by AQR Capital Management. They looked at U.S. stocks going all the way back to 1927. What they found was that at any given time, the stocks that were outperforming 80% of the market continued to outperform for at least the next 12 months. The same thing goes for the underperforming stocks. The bottom 20% of performers continued to underperform over the same period.
This idea is essentially the central concept underpinning relative-strength investing. Relative-strength investors will rank stocks based on performance, then buy the ones that are performing the best. They will sell that stock when the momentum changes course.
If it sounds too easy, that's because it is. Yet despite its simplicity, this strategy has been executed with staggering results.
For example, AQR found that using a relative-strength strategy, the asset-management firm was able to outperform their benchmarks in nearly every investing category (including mid caps, blue chips and small caps). What's more, James P. O'Shaughnessy, author of What Works on Wall Street , discovered that using a relative-strength based system would have beaten the market by an average of 3.7 percentage points per year over the last 83 years.
With that kind of track record, it's hard to deny the benefits of relative-strength investing. Yet as good as relative strength is by itself, it's been taken to another level by ProfitableTrading's newest analyst, Malcolm T.
In his newest trading service, Alpha Trader , Malcolm uses a unique investment system to leverage the powerful forces behind the relative-strength metric. He does so by combining a stock's relative-strength rating ( RS ) with a proprietary fundamental indicator. The combined values of these two numbers yield a stock's "Alpha Score." From what Malcolm has found, the higher a stock's alpha score, the better its chance of delivering blockbuster gains.
Take Amkor Technology (Nasdaq: AMKR ) for example. Malcolm's system originally tagged Amkor as a buy in late February, when the stock was sporting an Alpha Score rating of 162. Part of that Alpha Score was based on the stock's relative-strength rating, which at the time was 71. The other piece of AMKR's Alpha Score comes from Malcolm's proprietary fundamental indicator, which was then 91.
The chart below shows how the stock has performed ever since.
That's incredible... and it speaks volumes to the power of Malcolm's Alpha Score rating.
Of course, not all stocks with a high Alpha Score rating will jump this much. But nonetheless, on top of Amkor, the system has still highlighted 14 stocks that are currently up more than 30% in the past few months, and 21 stocks that have gained 20% or more within two weeks of the Alpha Score spotting it.
If you'd like to learn more about the Alpha Score, I urge you to view a presentation our friends at Profitable Trading prepared called " The Alpha Score -- The Secret to Doubling Your Money In 2014 ." It shows exactly how the Alpha Score works, and even reveals the name and ticker symbol of a top-rated Alpha Score stock flashing "buy." This presentation is coming down soon, so follow this link now if you have any interest in learning more.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
