Investing: Should the Past be a guide to the Future?

Friday, Apr 19 2013 by
4
Investing Should the Past be a guide to the Future

As regular readers of Stockopedia will know, we are big believers in learning from data and statistical techniques what investing strategies have worked when. This kind of "quant" thinking is embedded in our stock reports - which feature risk indicators that have been found to be predictive like the Piotroski F-Score - and in our screening centre where we are tracking the performance of a wide range of different strategies - from Quality to Value to Growth to Income over time.

Leveraging an analysis of what's worked well in the past to develop investment and risk reduction strategies for the future makes sense to us. As George Santayana once wrote, those who cannot remember the past are condemned to repeat it.  

The recent explosion of data availability and the falling cost of computing power also makes this kind of screening & modeling based on historically significant factors an important tool in the investing tool-box.

That said, it's also important to be careful with historical analysis too lest it lead you astray. It should serve as a useful device, but needs to be handled with caution too. 

3 Pitfalls to be Wary Of

As wise regulators the world over like to remind us, past performance is not necessarily a guide to future performance! This counsel is of course true at many levels and there are lots of potential pitfalls in naively extrapolating from the past, including:

  • Mean Reversion - Far too often investors suffer from the phenomenon of “performance chasing”. As soon as they see a hot asset class or sector, they pull their money out of their other investments and pour it into the new object of their affection. That's clearly a bad idea! Markets often experience mean-reversion (this means that, when asset prices deviate too much from their long-term trend, they will often come right back - for good or for ill).
  • Data Mining - As we'll discuss in another article, another danger of focusing too much on the past is excessive "data mining" or confusing correlation with causation. If you look hard enough, you will likely find some seemingly effective rule that looks great, in the past. The issue is that the market has only one past but many possible futures. Even if stocks have rallied the first Friday in June for the past 30 years, it doesn’t mean they will rally again…

Unlock this article instantly by logging into your account

Don’t have an account? Register for free and we’ll get out your way

Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


Do you like this Post?
Yes
No
4 thumbs up
0 thumbs down
Share this post with friends




What's your view on this article? Log In to Comment Now

You can track all @StockoChat comments via Twitter


About Stockopedia Features

Stockopedia Features

Stockopedia Features covers in-depth stories on strategies, companies and themes that are relevant to online investors. Investing is hard work. We don't try to over-simplify complex concepts - we prefer to try to help you navigate the detail.  more »


Stock Picking Tutorial Centre

Most Popular Now

Short Term Market Worries and Black Swans
Short Term Market Worries and Black Swans
Portfolio Management 4:55pm

Sinking feeling creeps up on shareholders
Sinking feeling creeps up on shareholders!
SKIL Ports & Logistics Fri 4:04pm


Bad to worse at LRM
Bad to worse at LRM
Lombard Risk Management Sat 1:50am



Let’s get you setup so you get the most out of our service
Done, Let's add some stocks
Brilliant - You've created a folio! Now let's add some stocks to it.

  • Apple (AAPL)

  • Shell (RDSA)

  • Twitter (TWTR)

  • Volkswagon AG (VOK)

  • McDonalds (MCD)

  • Vodafone (VOD)

  • Barratt Homes (BDEV)

  • Microsoft (MSFT)

  • Tesco (TSCO)
Save and show me my analysis
Foliobuilder