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The Most Profitable Thing I Learned in School

By Jeff Clark
Thursday, January 15, 2009

Statistics was my favorite course in college. Finding meaning in a bunch of numbers seemed like torture to most of my friends. But it was fascinating to me. And it's a big reason for the success I've enjoyed as a trader.
 
My college statistics professor was a big fan of the term "reversion to the mean." This is the concept that, over time, numbers will drift toward their long-term historic averages.
 
For example, in 1994, Hall of Fame baseball player and eight-time national batting champion Tony Gwynn was batting over .400 (meaning he hit an average of four base hits in every 10 times at bat) with just a couple months left in the strike-shortened season. He was threatening to be the first major league ballplayer to bat over .400 since Ted Williams did it way back in 1941.
 
Frank, my friend and a huge fan of the San Diego Padres (Gwynn's team), wagered $100 Gwynn would end the season batting over .400. Gwynn's lifetime batting average at the time was something like .330, so understanding the concept of "reversion to the mean," I had to take the other side of that bet.
 
Sure enough, Gwynn ended the season three hits short of the .400 mark. And Frank had to cough up $100.
 
Reversion to the mean applies to the stock market, too. I've often shared with you charts of the S&P 500 plotted against its 20-day exponential moving average (EMA). Historically, the index rarely strays more than 30 points above or below its 20-day EMA before reversing and coming back to test the line. So when the index moves outside of that range, I'll often place a trade betting on a reversal to the mean.
 
That's exactly where we are this morning. Take a look...
 
 
 
The S&P 500 closed yesterday at 843, roughly 50 points below its 20-day EMA (the blue line). So statistically, I'm looking for a bounce back toward the line.
 
Of course, trading on this one indicator doesn't always work out so profitably in the short term. Back in November, the S&P dropped over 100 points below its 20-day EMA. But even if you bought when it was 30 points below the 20-day EMA, while you had to endure some short-term difficulty, you were profitable by the end of the month.
 
Over time, betting on a reversion to the mean is one of the best ways I know of to profit off the stock market. In fact, it's the most profitable concept I learned in college.
 
Best regards and good trading,
 
Jeff Clark




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Earnings today... Genentech, Intel, JPMorgan Chase, POSCO.
Market Watch
Symbol Price
Change
52-Wk
S&P 500 1221.53 +1.3% +10.1%
Oil 37.77 +1.5% -2.8%
Gold 135.20 -0.1% +13.4%
Silver 27.93 +0.4% +47.9%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 19.39 -9.2% -8.2%
Gold Stocks 564.53 +1.3% +10.6%
10-Year Yield 3.00 +1.4% -9.6%

World ETFs
Symbol Price
Change
52-Wk
USA 122.56 +1.3% +10.2%
Canada 30.44 +1.3% +13.8%
Russia 21.63 +2.3% +16.7%
India 37.73 +1.9% +20.0%
Israel 16.47 +0.9% +9.7%
Japan 10.58 +1.0% +7.4%
Singapore 13.88 +1.0% +19.2%
Taiwan 14.72 +1.6% +17.8%
S. Korea 56.56 +1.7% +22.8%
S. Africa 70.85 +3.9% +22.9%
China 45.06 +1.4% +0.1%
Lat.America 52.82 +1.4% +6.7%

Sector ETFs
Symbol Price
Change
52-Wk
Oil Service 136.18 +1.5% +14.8%
Big Pharma 64.13 +0.6% -3.3%
Internet 72.13 +0.7% +22.3%
Semis 16.03 +2.1% +28.9%
Utilities 31.21 +0.3% +1.6%
Defense 18.51 +1.3% +10.1%
Nanotech 9.99 +1.3% +0.0%
Alt. Energy 9.95 +1.4% -4.4%
Water 18.31 +1.1% +12.2%
Insurance 16.07 +1.2% +18.3%
Biotech 20.58 +1.1% +27.1%
Retail 19.65 +0.1% +28.4%
Software 24.59 +0.9% +24.1%
Big Tech 53.73 +1.0% +21.9%
Construction 12.99 +2.1% +13.3%
Media 13.57 +1.1% +25.0%
Consumer Svcs 67.26 +0.8% +23.3%
Financials 54.87 +2.4% +5.2%
Health Care 64.22 +0.7% +1.3%
Industrials 63.25 +1.6% +19.7%
Basic Mat 73.57 +1.6% +21.6%
Real Estate 55.24 +1.4% +23.8%
Transportation 91.17 +1.4% +25.6%
Telecom 22.48 +1.1% +17.1%