Analyze market anomalies to improve investment returns

To succeed in the stock market, we don’t just need to understand the basic fundamentals, or have some skills in dealing in risk management, but we also need to have a suitable and robust investment strategy and know well how to use the various market anomalies to improve our investment returns.

Illustrative photo. @thebusinessplanshop

Illustrative photo. @thebusinessplanshop

Normally, before making an investment decision, the investor has to do a fundamental analysis, including analyzing the operations of the companies, the prospects of new projects and the status of debts and assets.

However, besides these above tasks, investors should also recognize abnormal events in the market to improve on investment results. Many investors do not understand the meaning and the role that market anomalies play. They even explain them incorrectly.

Below are some of the market anomalies that investors should take note of, as understanding them will help in achieving better investment results.

Neglected stocks

After many years investing in the stock market I recognize that I really like neglected stocks as they are usually trading at low price or at price which is lower than fair value of the companies.

According to Robert Shiller, who won the Economic Nobel Prize in 2015, and other several experts in the US stock market, neglected stocks tend to give higher returns than the average returns in the market. These stocks have low liquidity, hence, they are not of interest to most investors.

Excluding some companies which have shown bad performance or do not own valuable assets, the neglected enterprises are mainly operating in unattractive sectors which most investors, experts and investment funds neglect. However, when these companies post good growth potential or attractive financial ratios, the investors will be quickly interested in them, making their share price surge significantly and quickly.

Some stocks which are in this group include DHA, DHC, ASP, VIS, VCS and DAH.

Small cap companies tend to outperform

In his famous book on Irrational Exuberance, Robert Shiller used data from 1890 to 2000 to convince us that share price of small cap stocks outperformed the share price of big cap companies during certain periods of time.

For example, GAS finds it hard to double its price, however, ASP is easy to do in a short period. The growth of the companies will finally determine the movement of the share price and most smaller companies have higher potential to grow.

Low book value companies

The research also reveals that the stocks which have a ratio of market price to book value below average tend to outperform in the market. Many other studies also found that the portfolio which invests in low-book-value stocks has higher returns than the average.

The January effect

The January effect is a famous anomaly in the stock market. The message of this term is that the stocks which are underperformed at the end of the previous year will tend to outperform in the market in January of the following year. Furthermore, small-and-mid cap companies tend to outperform in the market in January as well.

The reason for this effect is that most of the small stocks are sold off at the end of the year. However, at the beginning of the New Year, the time that is considered good for investing in stocks, the individual investors tend to buy these small stocks at an attractive price.

Days of the week

Investors who believe in the efficiency of the market consider “days of the week” effect of the stock market as nonsense. However, studies found that the stock price tends to move more on Monday and Friday, with stock price usually moving positively on Friday.

In Vietnam stock market, though we do not have data to confirm this point of view, many traders have been interested in this effect. The correction of the stock market on Monday will be a good chance to buy while the positive movement of stock market on Friday will be a good time to exit.

“Sell in May and go away” effect

“Sell in May and go away” effect is also popular with investors. The stock market usually moves negatively in May as it mostly lacks positive events in this month.

In the second quarter, the escalating US-China trade war has impacted strongly the confidence of investors across the globe. This is also an example of “sell in May and go away” effect. Although this strategy does not work well in the long-term, it is meaningful with short-term traders.

Le Duc Khanh Dir. Market Strategy PetroVietnam Securities Incorp

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