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A Minority of Stocks Produce a Majority of Returns

A nice short piece from Eric Crittenden of Blackstar Funds via Michael Covel summarizing what accounts for the majority of the market's returns. It may not be as 'random' as you think and is a good starting point for those interested in trend following:

"Despite normally distributed random monthly returns, most stocks deliver below average results while a small minority produces virtually all of the market’s collective gain. The reason for this has to do with the asymmetric payoff structure of common stocks. Losses cannot exceed -100% while gains can be far greater than +100%.

(Normal distributions + randomness + time + limited liability) = a minority of large winners

Simulation of conventional academic theory and actual historical record both show that a minority of especially strong stocks account for the vast majority of the overall market’s gains. Every member of this minority shared one common characteristic. Each showed the propensity to appreciate to new all time highs, either more frequently, over longer periods of time, or with more acceleration than the majority of below average stocks. Each of these phenomenons meets the mathematical definition of a trend."