Fundamental analysis, buy and hold, value investing, CNBC, stock pickers, day trading–stop. Enough. Those typical investing approaches, popularized by media for decades, are not the way to build true wealth. Explore trend following and learn something different.
Here is what the complete Turtle Trader has to say on the subject of what is mean reversion and how following conventional investing methods as recommended by the TV shows and major investment websites may be just like panning for fools gold and are not really true wealth systems.
What is mean reversion? Over the long haul, market prices have a tendency to “revert to the mean.” That is, studies have conclusively shown that when stock prices (or any price, for that matter) get overextended to the upside (or to the downside), they eventually fall back in line with averages. However, stock prices do not exactly snap back into place overnight. They can remain overvalued or undervalued for ex- tended periods of time.
That extended period of time is the sandbar that sinks ships. People who bet on markets’ behaving in an orderly fashion (arbitrage) are panning for fool’s gold. Parker and the other Turtles learned a long time ago from Dennis that the hard thing to do is the right thing to do:
Mean reversion works almost all of the time. Then it stops and you’re kind of out of business. The market is always reverting to the mean except when it doesn’t. Who wants a system like we have, “40% winners, losing money almost all the time, always in a draw down, making money on about 10% of your trades, the rest of them are sort of break even to losers, infrequent profits”? I much prefer the mean reversion where I have 55% winners, 1% or 2% returns per month. “I’m always right!” I’m always getting positive feedback. Then, maybe in 8 years, you’re kind of out of business, because when it doesn’t revert to the mean, your philosophy loses.
Hearing Parker’s Southern cadence as he preaches about mean re- version hits home. Consider an example that makes his point: Let’s say an investor gives a trader money because his two-year track record shows he made 2 percent every month with no down months. Six years later, that same fund blows up and that investor’s retirement is gone because the strategy was predicated on mean reversion. It is human nature to believe in mean reversion, but as Parker says, “it just is a fatal strategy of trading the markets.”
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