Random Investment Strategies – Diversification at its Finest

12 years ago in 2001 a British pyschologist carried out an experimental in which 3 people, a professional trader, an astrologer, and a 4 year old girl, invested money in the UK start market.  Surprisingly, the little girl generated the most profit, 5.8%, while the astrologer lost 6.2% and the trader lost 46.2%.  In a recent paper an economist at the University of Catania in Italy, along with several colleagues, carried out a statistical analysis of past performance of the market and analyzed the performance of various strategies.  Their main conclusion was that on average, typical trading strategies do not perform better than a purely random strategy.  Although somewhat surprising, this does make some sense.  World markets are extraordinary complex and I think it would be safe to say that no one truly understands them.  A standard trading strategy is subject to numerous biases on part of the individual trader and given the wide variety of possible market states and conditions, it is inevitable that over time a trading strategy will fail.  A random trading strategy is immune from these biases and due to its simplicity, is very cost-effective to implement.

Of course, these findings do not suggest that everyone go out and begin randomly investing in stocks.  Warren Buffet certainly did not get into his position by doing so.  These results are a strong reminder however, of the weaknesses in our own models of world and the need for us to constantly revisit our own investment strategies.

http://www.technologyreview.com/view/512696/computer-simulations-reveal-benefits-of-random-investment-strategies-over-traditional/

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