A Non-Random Walk – Laredo Petroleum

“Las Vegas is busy every day, so we know that not everyone is rational.” Charles Ellis

Random walk is a stock market theory that states that the past movement or direction of the price of a stock or overall market cannot be used to predict its future movement (Investopedia).  Burton Malkiel, in his 1973 book “A Random Walk Down Wall Street”, states that both technical analysis and fundamental analysis are not proven to outperform the markets.

Random walk has had a significant grip on the investment community for over a half century, but with recent events including 2008 and the work of well-regarded academics like Robert Shiller, Richard Thaler and Andrew Lo (2002 Book, “A Non-Random Walk Down Wall Street”), that grip is beginning to loosen.  Readers of our weekly market call know that the theoretical underpinnings of our work in price trend analysis are based on the fact that patterns, and investor behavior, repeats.  We’ve validated that price movements are not random, based literally on hundreds of millions of pattern searches and more recently simulations and a white paper which highlights the predictive nature of price trends.

The following chart shows some recent simulation results over eight years and millions of pattern matches, investing in the top 1000 market cap stocks in regular intervals.  The results highlight that investing in the patterns showing the greatest consistency of investor behavior historically (both positive and negative) is predictive.  The navy blue line below shows the returns when we invest in the patterns having the top/bottom 10% most consistent reaction by investors and the light blue line is the return profile investing in the top/bottom 20%.

Not only is there a smooth and consistent return profile over the eight years, but you can see significant outperformance in the highly volatile period of 2008 and 2009.  Why?  As we’ve validated, investor behavior is always playing a role in prices, but of course there are many other significant factors driving prices including fundamentals, macro environment, events etc.  In markets driven by fear or euphoria, investor behavior is playing a larger role and therefore having a proxy for investor behavior becomes even more critical….and profitable.

There is significant and statistical value in understanding price trends by themselves, but we continue to feel that there is even greater value when these statistics are presented to an experienced investor to be considered with other significant fundamental, global macro and technical factors.  To emphasize the point, we’ve found a compelling, “top decile”, price trend in Laredo Petroleum, Inc. (LPI) where we’re providing not only the projection for the next one month, but also some easy to digest analytics that supports it.

3 month price chart for Laredo Petroleum (LPI)

In seconds, EidoSearch finds the most similar instances of this pattern historically in Energy Stocks.  We’ve listed the top 18 results here, where you can see the stocks and periods of time where this current price pattern occurred.

Chart displaying the forward returns of these 55 most similar historical instances of this current 3 month price pattern in Energy stocks.  The average return in the next one month is 6.7%, and the deviation of historical outcomes to the upside is much more significant.  There is only one instance of this pattern being down historically more than 10%, and 15 instances above 10%.

Have a great week!