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Ignat's Law
Ignat's Law states that the only reason stock portfolios under-perform the market is because they hold stocks that under-perform the market. That is self-evident. Not only that but the implication is that portfolios heavy with under-performing stocks almost never outperform the market. It does not require sophisticated statistical analysis to arrive at Ignat's law. The academic community has been searching for the explanation for why so many professionally managed portfolios under-perform the market for years. The answer is right under their nose.
The better question is why do professionally managed portfolios hold so many stocks that perform so poorly? One answer is that a stock's performance is not a criteria that is used to determine whether a stock should be retained in the portfolio. Therefore a stock's performance is not measured and performance is not the basis for deciding whether a stock should be retained in the portfolio. Factors other than performance determine whether a stock should be retained in the portfolio, such as analyst's recommendations, portfolio managers egos, company public relations efforts, loyalty to company managements, personal commitments to predictions and the list goes on and on. All of these factors explain why Ignat's law is so pervasive.
The central idea that is promoted by the academic community is that a stock's price performance is random and therefore unpredictable - so why measure a stock's performance? This goes back to the idea that is aggressively indoctrinated into under-graduate finance majors that stock charts are meaningless and of no value. Stock charts can be used in many ways - to predict or to record and to measure performance. Predicting doesn't work but measuring the trend of a stock's price movements provides important information to the investor.
Let's agree that all stock price movement is random and unpredictable, unpredictable by any means, fundamental, technical analysis, quantitative, astrology, numerology, occult or otherwise. That does not in any way indicate that stock prices do not move in trends. Trends are observed all the time - They just cannot be predicted with any meaningful degree of reliability. While they cannot be predicted, they can be recorded and measured to recognize when they change direction and change in strength. The investor does not need to predict the future trend of a stock price as much as he needs to observe when the trend changes direction in a meaningful way.
The best way to observe the trends of a stock price is with a chart of the stock price. There are accepted methods to damp out the noise in stock prices and to remove the influence of the movements of the overall market. This leads to charts of relative strength, especially in a long-term point and figure format. The three-box point and figure method acts like a filter on the price data and the noise is suppressed. The relative strength removes the influence of the market and the movement that is specific to that stock shows up on the chart. That's how we get a good look at the trend of the performance for an individual stock.
Trends of relative performance that last for long periods of time show up clearly on this type of chart. These trends may be random day-to-day but the bias in the daily movement shows clearly until it fades and when it fades, that is very important information to the investor. There is no requirement that these charts be predictive at all. They just need to show when the trend changes direction. The academic community has totally missed the boat on the value of charts and seasoned investors learn this lesson the hard way. Unfortunately, many, many investors become so thoroughly indoctrinated in the belief that stock charts are worse than worthless that they never learn to use them properly and their portfolios suffer when the trends of their stocks turn down.
There are many, many factors that determine a stock's performance in the market. Some of these factors are real and some can be purely emotional and some can be manipulative, but only the performance of the stock is what counts. These trends of performance are usually not accidental even though they may be random and they usually reflect the actual performance of the company. This is not to say that emotional responses are not important. The important conclusion is that the trend of performance is the only thing that counts - not the factors that caused it.
Ignat's law suggests that investors need to measure the performance of their stocks and move away from the stocks that don't perform well and invest and hold stocks that do perform well for as long as that performance persists. It seems to be a simple proposition but it does depend importantly on the process for measuring the performance of the stocks in the portfolio.
