Anatomy of a Market Beater: Part VII

In this series, I’ll be exploring whether there are any useful characteristics that separate stocks that beat a given benchmark index (“winners”) from those that lose (“losers”).

Suppose the benchmark index you are using is the NASDAQ.

Also, suppose that we are comparing stocks against the NASDAQ over a period of 365 days (the “test period”).

I ran 1,000 randomized trials on existing NYSE and NASDAQ stocks whereby for each trial: (1) a random date was chosen, (2) every existing stock was compared against the NASDAQ index over the period beginning with that random date and ending 365 days later. The stocks for each trial were grouped into either “winners” or “losers” depending on whether a stock’s overall growth over the 365-day period was greater (“winner”) or lesser (“loser”) than the NASDAQ.

The winners and losers were compared by days a stock would be beating or losing against the NASDAQ, the amount of that gain or loss (margin), and the absolute gain or loss that stock was experiencing.

Here’s what I found.

VII. Cumulative Overallbeatpct of Winners versus Losers

If we map out the progression of median beatpct of the winner stocks versus the loser stocks at each point in time along the investment period from day 1 to day 365, we would get something that looks like this:

Figure 1. “pulloutpct” means “overallbeatpct”.

What I mean by “beatpct” is the proportion of days in a given period that a stock’s normalized price graph was above that of the benchmark (NASDAQ) (see previous article for a detailed illustration). So, for example, at testday 50, a typical winner stock over the period from day 1 to day 50 would have a normalized price graph such that 62% of that 50-day period would be above the NASDAQ’s normalized price graph.

So, returning to Figure 1, we see the winner median beatpct in blue, the loser median beatpct in red, and the winner minimum median beatpct in green, and the loser maximum median beatpct in yellow.

Remember, this is an aggregation of 1,000 trials, so each line above is the median of 1,000 trials of median beatpcts for each group of winners and losers. In other words, on each day, in each trial, each winner’s beatpct is calculated. The median beatpct out of all the winners of that day of that trial is calculated. Since there are 1,000 trials, there are 1,000 samples of that median beatpct. So the blue and red lines above represent the median, median beatpct of a winner or loser stock respectively. The green and yellow represent the minimum and maximum, median beatpcts respectively.

Figure 1 is not visually surprising as stocks that beat the market overall tend to do progressively better than those that don’t on a daily basis.

Because Figure 1 above is an aggregate of 1,000 trials we’d probably want to know how variable the figures of that aggregate are. In essence, how reliable is Figure 1?

Figure 2. “pulloutpct” means “beatpct”.

The blue and red lines represent the spread of beatpct within the winners and losers groups respectively. (Note because this is an aggregation of 1,000 trials, “spread” really means the median spread over those 1,000 spread samples). Both winners and losers within their own ranks tend to have high variability in their beatpcts, but it decreases as the days progress down to 20%.

The green and yellow lines represent the spread of median beatpcts of the winners and losers respectively over 1,000 trials. In short, they represent the spread of the lines in Figure 1 above. The spread over 1,000 trials is rather small, hovering around 10% and decreasing as time progresses.

What this says is largely two things.

First, that identifying whether a stock is a winner or loser based on its beatpct on a given day is not very useful because their beatpct vary widely (see Figure 3, blue and red lines). For confirmation of this, look at the actual range of beatpcts that winners and losers possessed over these 1,000 trials:

Figure 3. “pulloutpct” means “beatpct”. The blip at the end is the fact that a winner is defined by beating the NASDAQ at the end of the 365-day investment period. So at a minimum, a winner must be greater than the NASDAQ in overall gain on the very last day, which equates to a beatpct of 1/365 or 0.27%, which is where the tip of this blip is.

Figure 4. “pulloutpct” means “beatpct”.

Winners and losers can experience nearly the same types of beatpcts as the other save for the last day, as that is the day that defines winner from loser: if you have a higher cumulative gain than the NASDAQ by period’s end, you are a winner, if not, you’re a loser.

Second, that identifying whether a group of stocks are winners or losers based on their collective median beatpct is not as bad of a gamble as guessing the status of a single stock because the spread is rather narrow (see Figure 2, yellow and green lines) while their regions are divergent (see Figure 1).

Here’s Figure 1 again but this time each line is bounded by lines representing +- 1.5* median absolute deviation of their medians:

Figure 5. “pulloutpct” means “beatpct”.

If a group of stocks you have is experiencing X median beatpct on day Y, and X exists outside of the winner region bounded in Figure 5, then you should consider the possibility that at least one stock in your group is likely not going to be a winner by year’s end.

The point at which these two regions diverge (where the orange line and green line stop overlapping) is day 78 where the median beatpct for a loser plus 1.5 times its median absolute deviation (MAD) is 45.9% and 46.2% for that of a winner.

Let’s say you have a portfolio of stocks of which you have held for 200 days. You calculate the median beatpct for your portfolio to be 21%. That would place it squarely in the middle of the losers region at day 200 in Figure 5. Your portfolio would to a high degree contain stocks that by day 365, would not beat the NASDAQ and therefore you should consider exiting your positions.

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