In case the image below makes you think I’m quietly going insane, I am not going to talk about using sunspots as trading signals.
(Although, now that I think about it, sunspot activity does influence climate and climate does influence the economy and the economy does influence the stock market – hey maybe I should be using sunspot activity!)
Let’s get back to the point – and the point is how to avoid unreliable trading methods.
The Spots are Wrong
I remember reading about a researcher a long time ago who took a huge amount – many, many years’ worth – of sunspot data. He used the data to build a new model of sunspot activity. The model seemed to perform brilliantly. When asked to predict sunspot activity at any time in the past, it did so perfectly. But its predictions of future activity were woeful.
The Fools are fools
In similar vein, the Motley Fool’s much hyped Foolish Four technique attempted to beat the stock market. Apparently, by spending just 15 minutes a year, you could crush other investing strategies. The method had worked for 25 years, beating the Dow by 10 percent a year.
The 15 minutes work consisted of:
1. Find the five stocks out of the 30 stocks in the Dow Jones that have the lowest price and highest dividend yield. (Divide the yield by the square root of stock price.)
2. From the five selected stocks, buy equal dollar amounts of the stocks ranking the second, third, fourth and fifth highest. Discard the highest-ranked stock.
3. Repeat annually until rich beyond the dreams of avarice.
Methods Need to Work in “The Now”
Naturally enough, as soon as this nonsensical method was faced with “the now” instead of “the past” it failed – totally.
All that the sunspot researcher and the Fools showed, in my opinion, was that they didn’t understand numbers.
If you take a large amount of data – as the Fools did – it will contain number patterns. Often these patterns have occurred through mere chance. Sometimes they have a real cause. The Foolish Four latched onto a chance pattern and confused it with reality. Here’s what they said:
“With a Spartan commitment of just minutes a year for research (entailing not much more than clicking into our Today’s Stock List page once a year, figuring out the amount you need to put in each stock, and placing your trades), you can use a strategy that has thrashed the Wall Street professionals for decades. How very Foolish!”
Well, at least they got one thing right.