Friday, November 11, 2011

buy the worst

Buy low. Sell high. That's how you beat the market, right? Sounds simple, but it's not.

Buying while everyone you know and respect is selling is not easy; nor is it a simple task to cash out while your stocks are setting record highs with each passing day. Carlson's method attempts to circumvent these emotions, which betray our better investing sense.

In a basic sense, here's how it works:

• Find out which five stocks in the Dow Jones Industrial Average (INDEX: ^DJI ) have performed the poorest over the past year.
• Buy those five stocks (forcing you to buy low).
• Hold them for one year.
• Sell those stocks (forcing you, theoretically, to sell high).
• Wash, rinse, repeat...

Carlson went back to the 1930s and ran the numbers: "What I discovered was that buying a basket of the Dow's worst-performing stocks (I call these underachieving stocks "Dow underdogs") and holding them for a year outperformed the Dow by a wide margin going back to 1930. What's more, the strategy has been even more profitable over more recent time periods, including the last 10 years and especially during the volatile markets since 2000."

The theoretical underpinnings make sense. Carlson is self-selecting from a group of 30 very mature, well-established businesses; there are no rocket stocks or start-ups here. And as a group, they serve as a fair proxy for the larger market (actually, to some, they are the proxy). By buying the poorest performing members of this group of 30 and holding them for a year, Carlson believes that on average, those stocks will revert to their mean, and outperform their peers.

Carlson admits that this year, the system doesn't seem to be working. That being said, there are still several weeks left in the year for performance to turn around.

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