Finding patterns in data is one of the best quantitative strategies investors can utilize to improve stock returns. The only downside of pattern searching is that it depends on historical data. If the past does not repeat itself, the strategy breaks down.
So what are some tactics investors can use to increase the odds in their favor? Here are three simple quantitative strategies for the average investor.
Low Volatility Equity Strategy
A number of major funds manage their investments using a low volatility equity strategy. That process is built on momentum, quality and value. When an investing opportunity fulfills all three factors, it should result in a return that is above the industry standard.
Investors may use a service like Stock Rover to get the value scores on all three factors. Momentum, also known as sentiment, measures the stock’s price performance relative to the market. For example, the more buyers there are, the higher the momentum score.
Per Stock Rover, a quality score “compares profitability and balance sheet metrics to find high quality companies. Our computation includes ROIC, Net Margin, Gross Margin, Interest Coverage, and Debt / Equity ratio values. The best companies score a 100 and the worst score a 0.”
When it comes to value, a “value score looks at EV / EBITDA, P/E, EPS Predictability, Price / Tangible Book, and Price / Sales. The Price / Tangible Book and Price / Sales values are compared within a sector whereas the other metrics are compared across all stocks with adequate data. The best companies score a 100 and the worst score a 0.”
When it comes to finding stocks with low volatility, Stockcharts has a six-step approach for measuring a stock’s volatility. Investors may use that data to pick stocks having the lowest volatility, therefore the lowest related market risk.
Meeting Company’s Management Team
A quantitative research approach may include meeting the company’s management team. In general, senior managers in a mega-capitalization company will not have any time to meet with ordinary, small-time investors. Instead, its investor relations department will answer any questions. So, investors could look at very small companies.
There, the management team may offer a unique insight into the company’s positive prospects ahead. Getting a deeper view of how a company operates, why it has future strong growth that markets do not notice, and knowing why shares trade at a steep discount will give investors an edge.
Investors who have access to plenty of data sets may build statistical models to improve stock returns. With a data set in hand, the investor may look for relationships, patterns, and factors. Once found, the investor will need to backtest the pattern or correlation with historical data.
Once the investor validates the statistical model, writing algorithms is the next step. This will still require backtesting against the historical data to validate that it works. If it passes, there is a higher probability that the investor will produce improved stock returns.
Nothing stays the same forever. So, if past patterns change, investors need to revise the model. To do that, knowing why a usually repeatable pattern changed is paramount to fixing the model.
Building statistical models are often beyond the capabilities of the average investor. So, knowing what approaches professional quantitative managers use opens another opportunity. Investors may seek a quant manager that has a good track record of producing above-average returns.
Sometimes, the busy investor is better off hiring a skilled manager to handle the stock picking. These advisors will have proprietary models. So, those hiring someone will benefit from the use of models that no one else has access to.
Even though there are fees to pay and the need for trusting someone else, the goal of beating the market is the same.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.