Stock Market Opportunities Never Last
I often read about stock trading strategies that promise to produce outsized returns with very little risk. They often sound really good and the back testing looks impeccable. The problem of course is that once a strategy promises to produce easy money, the market takes notice, and the previous patterns reverse.
An interesting example I came across recently is the index inclusion effect.
The phenomena describes the tendency for a stock’s price to spike on news that it will join a widely followed benchmark like the S&P 500, only to fizzle following the change.
The rationale seems solid. Every ETF and mutual fund that tracks the index must purchase companies as they get added to ensure the funds accurately track their benchmark. The size and scale of the forced buying inflates the share price giving investors a quick profit and an opportunity to sell before the price goes back down.
It should be easy money. Except that trade no longer works like it used to. As this article from Morningstar points out, the index inclusion effect looks like a thing of the past.
This same truth repeats over and over, and the takeaway is simple. When someone says they have a stock trading strategy that relies on back testing, no matter how good it looks, proceed with caution.
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