T2W Trading Community

The historical statistical research was completed by FAMA & FRENCH and the current research to the present by myself. From an equally weighted portfolio of common stocks, returns are as follows:

From an industry perspective (2001 – 2005):

What we see is the law of large numbers. The returns from the industry far outstrip the aggregate return on individual stocks. For the P/E to double, the price must double, with earnings remaining static. Therefore we have an increased return, with increased safety due to the principle of diversification.

Now, we can see from the above results that in 4 years the leaders fell, and the laggards improved. This has been a consistent finding, statistically demonstrated by FAMA & FRENCH in their results that almost cover a 60 year period.

Diversification, as a way of reducing risk, was adopted from the insurance industry. Actuarial tables were compiled on mortality rates, incidence of fires per 100 households and weightings for “moral hazard” calculated. The resulting calculation provided the premium that would need to be charged, to ensure an “aggregate” profit for the insurance company. This methodology was successful, and has stood the test of time within the insurance industry. This principle has been almost universally accepted within the investment community for the management of  risk. Today it is possible to buy “ETFs”, or Exchange Traded Funds, for diverse industries. This is a cheap and very effective way of practicing diversification with absolutely no effort.

In summation: We buy an ETF for an entire industry. We buy a low P/E ratio industry ETF only. We can buy multiple low P/E ETFs, where "low" means a P/E of <10. We time said purchase using qualitative judgement of the chart pattern. No stop loss is required as we eliminate attrition of our capital immediately. We reduce trading costs substantially. No specialized trading platform is required.

When do I buy? Assuming the relevant P/E ratio is favourable, observe a weekly or monthly chart. If the chart shows consolidation, is in a trading range, is boring and doing nothing much then the crowd is absent and it is safe to enter because you have beaten the crowd to the entry. Now you just wait. No need for a stop loss (provided that you are diversified). No manic entries or exits, just sit there until up it goes, and you sell out to the arriving crowd.

When do I sell? If the research is correct, and at this point there is no evidence to contradict the findings, very aggressive traders will sell when they have a 100% improvement in the P/E on purchase price. Conservative traders or investors may settle for a 50% improvement in the P/E ratio. A third selling point would be a historically high P/E. If we bought at a P/E of 8, and historically the industry never went above a P/E of 15, we would not hang on waiting for a P/E of 16. We would sell at 14. Either way, the returns are satisfactory. Or, from a technical perspective, when you encounter a significant point of resistance, on a weekly or monthly chart.