Review of ‘Being Right or Making Money’

Debashis Basu 24 December 2015

One of the finest independent research houses shares its timing model

Ned Davis started his independent investment research firm, Ned Davis Research (NDR), from a residential apartment in Florida, far away from Wall Street, in 1980. Over the years, the firm has developed a reputation as an independent, institutional research company, by offering unbiased, in-depth analysis. Nearly every major institutional investor subscribes to its research backed by sophisticated analytic tools that detect patterns from of a huge, decades-long, database of statistical information on the markets and the economy.

Davis and his colleagues have published a few books, including an oversized chart-book, Markets in Motion, which showcases the depth of their research. Being Right or Making Money, published many years ago, has been out of print for years. The hardcover edition was being sold for $430-odd on Amazon. A new edition of the book was published in 2014.

NDR’s research stands out for its methodical approach to market-timing. For equity market-timing model, the firm used more than a 100 proprietary indicators picked from market data of price and volumes, sentiment (including valuation) and macroeconomic data, mainly monetary data. NDR has timing models for bonds, commodities and gold as well. All the indicators are robustly back-tested so that the firm has a clear idea of the odds. From this, it makes informed guesses about what the market will do now. Unfortunately, while individual investors will get a glimpse at how NDR builds its timing models, they will not be able to replicate it. For retail investors, it is impossible to get access to all the data and update the model regularly.

The book would be useful mainly for portfolio managers, mutual funds and equity research divisions of broking houses. But Davis does have a set of dos and don’ts for individual investors, based on his 40 years of experience:

Don’t Fight the Tape: This is an old Wall Street maxim. It means you need to stay with the broader trend. Davis uses dozens of indicators, such as new high/lows, up/down volumes, crossover of 50-day moving average over 200-day moving average, etc, to decide whether the trend is up or down. According to NDR, moves with a lot of confirmation are the healthiest and huge moves are, usually, global in nature.
Don’t Fight the Fed: Money moves the markets. The United States’ Federal Reserve (the Fed) exercises enormous influence on money flows which, in turn, deeply influences stocks. When the Fed is easing money flows, stocks rise. When the Fed is tightening, stocks fall. Stay in sync with monetary trends set by the central bank. Money left over from economic demands ends up in the financial markets, at least in the US.
Beware of the Crowd at Extremes: All trends run to the extremes and then end abruptly. This surprises the majority who continue to extrapolate the recent trend. At that point, it pays to be a contrarian. How to spot such extremes? Extreme optimism equals low cash, while extreme fears shows up in high cash levels.
Rely on Objective Indicators: The surest way to lose money on stocks is to go by faith, gut-feel, intuition and so on. You need to rely on hard, cold data that has been tested to work in the past.
Be Disciplined: You need the discipline to ignore the noise created by the media. Stay away from rumours, guesses and hot tips. Stay away from everything other than what you have actually tested and found to be working in the past.
Manage Risk: According to NDR, “We are in the business of making mistakes. Winners make small mistakes, losers make big mistakes.” NDR ensures that its mistakes are small, by using stop losses and a lot of trend-sensitive indicators.
Remain Flexible: While it is important to remain disciplined, you should also be flexible because markets change and causal relationships change, though over the long term.
Money Management Rules: “We are more interested in making money than being right,” writes Davis. “Be humble and flexible.” Retail investors are usually unaware of it and end up investing either too much in a stock or too little.
Study History: Those who don’t study history are condemned to repeat it. The core of the market—an interplay of liquidity, sentiment and valuation—has remain unchanged over the years. Davis advises model-builders to go as far back as possible in history, to collect and analyse data.

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