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Is it possible to beat the stock market?

In the days before Hungarian psychologist Laszlo Polgar was married with kids, he developed the idea that genius is acquired, not innate. He believed that by taking the right approach to education, every child has the capacity to be a genius in any field. To prove his point, he married a Ukrainian teacher named Klara Alberger, who agreed to help him test the theory with one of the most fascinating pedagogical experiments ever conducted. From a very young age, their daughters Susan, Sofia and Judit were intensively trained to be chess prodigies. Nothing was left to chance: endless hours of practice, expert mentoring and access to a catalogue with analyses of 200,000 outstanding games by professional players. You’re probably dying to know whether this experiment on extreme specialization was conclusive.

Based on the Polgar sisters’ achievements, the answer is yes:,

  • At her peak, Sofia was the sixth best female chess player in the world.
  • At age 15, Judit became the youngest chess player to earn the title of International Grandmaster.
  • When she was a teenager, Susan accomplished the extraordinary feat of playing blindfold chess (meaning without seeing the chessboard) against five opponents at the same time.

Is it possible to train someone to be a genius on the stock market?

Some people might want to apply this approach to playing the market. If you dedicate a significant amount of time and effort to analyzing economic data and corporate financial statements, reading reports and creating predictive financial models, success should be guaranteed, right? Unfortunately, no.

In chess, players get the chance to test what they learn and put it into practice because of immediate, accurate feedback in a stable environment where the possibilities are both known and limited. But in the stock market, unpredictability makes relying on specialization a bad bet for investors. Regardless of your investment methods and your perspective, or the perspective of a financial expert, you have to pay close attention to how the markets behave. And unlike chess, that depends on the actions of thousands of other people. Whether you like it or not, the profitability of a given investment strategy is determined by the prices set by market participants. Based on this principle, it’s better to be a generalist than a specialist.

That's why I'm suggesting you expand your horizons by factoring human behaviour into your investment process. The S&P 500 Volatility Index (VIX) is a highly useful indicator that can help you do just that. The index's historical average is 18. Usually, a higher reading reflects rising anxiety among market participants, while a lower reading suggests the contrary.

The VIX can tell you when to buy

Did you know that since 2013 the S&P 500 has hit a historic high more than 200 times?

This means that opportunities to buy stocks at attractive levels are increasingly rare. One way to ensure you buy at a good time is to invest in the S&P 500 when the VIX is below 30. The goal is to take advantage of lower market prices that result when there’s some panic in the market. In a given six-month period between the start of 2013 and the end of 2018, this tactic would have consistently beaten the market at a time when the S&P 500's average return was more than 12%.

Of course, past performance is no guarantee of future results. However, as long as the global economy doesn’t fall into a recession, you can successfully beat the market and generate satisfying long-term returns.

Sources

Epstein, D. (2019). Range: Why Generalists Triumph in a Specialized World. Riverhead Books.

Hogarth, R., Lejarraga, T. and Soyer, M. (2015). The Two Settings of Kind and Wicked Learning Environments. Current Directions in Psychological Science, Vol. 24(5), p.379-385.

Krausz, T. (2017). The Queens of Chess. The Jerusalem Post. This link will open in a new tab. http://www.jpost.com/Jerusalem-Report/The-queens-of-chess-491007. Retrieved July 3, 2019.

People Staff (1987). Nurtured to Be Geniuses, Hungary’s Polgar Sisters Put Winning Moves on Chess Masters. People. This link will open in a new tab. https://people.com/archive/nurtured-to-be-geniuses-hungarys-polgar-sisters-put-winning-moves-on-chess-masters-vol-27-no-18/. Retrieved July 3, 2019.

1People Staff (1987)

2Krausz (2017)

3Epstein (2019)

4Krausz (2017)

5Hogarth, Lejarraga and Soyer (2015)

6Epstein (2019)

7As calculated by David Beaudoin, a professional trader and quantitative portfolio manager

The author

Michel Villa

Michel Villa

Speaker, stock market blogger and trading coach