Also assumptions.
I think an underlying assumption of indexing is that, in the long term and in real terms, the market will grow and market returns will continue to permit a SWR of 4% because the curious, creative, clever and industrious nature of humankind will keep bringing new ideas to the market because it always has.
An underlying assumption of dual momentum is that market returns and losses will continue to be amplified because the greedy, fearful, conforming and often irrational nature of humankind will keep bringing emotion into the market because it always has.
Indexing comes from a more positive mindset, and I know MMM is a crazy optimist but maybe dual momentum is more realistic. Either way, the DM assumption seems just as reasonable as the Indexing assumption.
Indeed.
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"<Insert Strategy Here> is part of the 1% of strategies which beat over half of all invested dollars in the past X amount of years. While this information is public, I do not expect the losers to adopt my published strategy, or change to a better strategy, so I expect it to continue beating over half of all invested dollars in the future."
Compared to:
"Indexing beat or matched half of all invested dollars in the past,
I do not expect mathematical laws to change, so I expect it to beat or match half of all invested dollars in the future."
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The whole "human emotion" justification to explain why a particular strategy backtests well, is by no means new. There's always a hook. In fact, I'd say the majority of active strategies I've come across over the years, play that same hook to much fanfare. The funny thing is, it can be used both for trend following strategies, and for reversal strategies! I've seen it argued for strategies like the one in this thread, and I've seen it argued for buy and hold indexing, I've seen it argued for day trading strategies, and everything from "buy the dips", to "buy the breakout", to "buy only when you see this specific chart pattern over the last 15 minutes - 3 hours"...I could go on and on. For someone new to active trading, as I suspect many people on this forum are, you might not have seen this before:
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"The market is made up of humans, and by human nature we are afraid of loss, therefore you should
sell when the market looks SCARY and moves up to X!"
"The market is made up of humans, and by human nature we are afraid of loss, therefore you should
buy when the market looks GREAT and moves up to X!"
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With X being the same value each time. Sometimes the strategies even link to
psychology experiments, which point to certain deficiencies in the brain, which lead to seeing patterns which aren't there, therefore you should buy/sell at X. My favorite was
the mouse experiment. They took a group of Yale students, and showed them two boxes. A piece of cheese would show up 60% in the left box, and 40% in the right box, but the students weren't told this. They were just told to try and get the most amount of cheese possible. The students ended up creating some complex algorithm to try and predict where the cheese should show up. In the end, they only got the cheese 52% of the time, and when asked they were all convinced they were making headway in solving the riddle.
At the same time, they ran the experiment with a mouse in a maze. After the first few trials, the mouse figured out that the cheese shows up on the left more often than not, and as a result just choose left each time. The mouse got the cheese 60% of the time, beating the Yale students!
Now comes the fun part! The trading strategy says, "Be like the mouse! Buy/Sell at X!" The trouble was, you could make the argument either way. "X has just moved up considerably. Be like the mouse, you already have the cheese, stop trying to capture more, just settle for what the market gives you. Sell everything!" Or, "X has just moved up considerably. Be like the mouse, the market is telling you where the cheese is. Buy everything!"
Indeed, these type of hooks can seem promising, even exciting. My advice to any newbies in this thread,
don’t fall into the trap. You buy the market not because it promises to exploit the “human emotion” factor, making you rich in the process. You buy VTSAX, the
Total US Stock Market Index Fund, simply because you want to capture the market. Again, indexing beat or matched half of all invested dollars in the past,
I do not expect mathematical laws to change, so I expect it to beat or match half of all invested dollars in the future.
You don’t buy VBTLX, the
Total US Bond Market Index Fund because it less volatile in the past, but because
bonds are a written contract, where you are paid periodic interest payments, and in the end you get your full investment back. In most cases (70% of VBTLX) the contract is guaranteed by the government. This makes it a relatively safe place to put your money.
Sol put it perfectly:
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People don't choose indexing because it backtests well against an index. They choose indexing because they want to get market returns, good or bad, without taking on any additional risk by trying to beat the system. I choose indexing because I'm prepared to play the game straight and accept average returns the same as everyone else is getting, at the lowest cost to me. I'm not trying to win at anyone else's expense.
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As did Brooklynguy:
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If you use backtesting alone, you have proven nothing more than the fact that the strategy has worked in the past. It is textbook survivorship bias to draw a conclusion solely from backtesting, because you are ignoring the infinite number of conceivable and backtestable strategies that failed to work in the past. If you backtest enough strategies, you are bound to find one that worked through random chance alone.
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Assuming the strategy in this thread is indeed based solely on backtesting, my advice to any newbies would be to proceed with caution.
Survivorship bias is the single greatest fallacy in investing, and it’s better to find out now, than after 16 years of underperformance.