Individual investors often point to the long-term success of Warren Buffett as proof that value investing works. They are correct, and Buffett is just one example of the many long-term investors who have found success with value investing.
However, although value investing can work, many investors fail to succeed with this strategy.
I think the reason value investing is so difficult to implement is because it is challenging to define exactly what "value" means. Some investors use the price-to-earnings (P/E) ratio and buy when the P/E ratio is low. Others search for stocks with low price-to-sales (P/S) ratio in their hunt for value. In addition to these two tools, there are dozens of other ways to measure value. In the right hands, and with enough time, any disciplined approach to value investing should work in the long term.
Another well-known investing strategy is buy-and-hold, or index, investing, which is an admission on the part of the individual that they cannot beat the market and are willing to accept all of the losses in a bear market with no chance of outperforming in a bull market.
Momentum, or relative strength (RS), investing is a less widely known approach among individual investors, but it is one of the most exhaustively tested investment strategies. This strategy was first shown to work in an academic paper written in 1967 and was widely accepted in the academic community by 1993.
Since then, studies have shown that RS continues to perform well, and additional research has demonstrated that RS strategies can be applied successfully to international stock markets. These studies generally rely on data from the recent past, using 50 years or more of data in many cases and ending near the time the article was published. The paper published in 1993, for example, looked at data from 1927 to 1989.
One recent study looked further back in time to see whether RS worked even before anyone understood what RS was. This paper looked at how RS would have performed from 1801 to the end of 2012. The authors concluded that RS would have outperformed a buy-and-hold strategy over the entire 212-year period.
No investment strategy, including value investing or RS, will work all of the time. In the long-term study, returns for an RS strategy are broken out by decades. The RS strategy has beaten the market in 18 of the 21 full decades (86%) in the study. It underperformed in the 1890s, 1900s and 1920s.
My 26-week rate of change (ROC) system is one way to implement an RS strategy, and this system also has a long history of success. Given that the future stock market action, in the long term, is likely to be similar to the past, we should expect RS and the 26-week ROC system to continue working in the future.
These strategies often go for weeks or months without making trades, and once again, there are no changes in the 26-week ROC model portfolio, which continues to hold four positions:
This article was originally published at ProfitableTrading.com:
This Strategy Has Worked Since 1801 and Is a Good Bet for 2014