Investment results always depend not only on the chosen investment strategy, but also on how lucky the investor is. If he started investing during a market rise, a good fortune awaits him. But if he entered the market before it began to fall, the results will be poor. How can we separate out how good the investment strategy itself is, and to what extent the result is determined by the characteristics of the market over the investment horizon?
If we consider many relatively small periods of time over the investment horizon (months), we can separately examine the strategy’s results in those months when the market was growing, and in those months when the market was declining.
Our strategies are characterized by the fact that when the market is growing, the strategy’s return as a whole grows more than the market, and during those periods when the market is declining, the strategy often also declines more than the market. But here’s what’s interesting: the average outperformance of the market by the AVI strategy during a market rise is greater than the average decline, relative to the market, during a market decline. This happens with any of our three selected AVI strategies.
Therefore, when the market declines, the strategy loses less than it gains when the market rises. Consequently, if, say, the number of periods of decline is equal to the number of periods of growth, then the strategy will beat the market. This excess of the strategy’s average growth over the market growth in market growth situations over the excess of the average decline in relation to the market decline in periods when the market is declining is what we call the “Strategy Strength.” If the Strategy Strength is, say, 1%, this means that for every market growth in 1 month, the strategy wins, on average, 1% compared to the loss in those months when the market is declining. If during the current year there were 6 months of growth and 6 months of decline, then the strategy will outperform the market for such a year by 6% on average.
But if during the year all 12 months were months of market decline, then the strategy will lose to the market. In this case, the market simply didn’t give the strategy any chance to outperform it. Strategy Strength had no chance to shine in such a year. This second factor—how many periods of growth and decline there were over the investment horizon—is a matter of chance; it doesn’t depend on the chosen investment strategy, but is a random factor for the investor.
Choosing a strategy with high Strategy Strength is the right, wise choice. But whether the investor will be lucky or unlucky is a matter of chance. Thus, the “Strategy Strength” parameter allows one to determine how good or bad a strategy is in itself, regardless of the vagaries of the market.
Fortunately, over long periods, the number of months of market growth outpaces the number of months of market decline. The market as a whole grows over long investment horizons.