Top stocks for 2007 - Part 2

In my earlier post on Top Stocks for 2007 I talked about need for a sound concept if you want to make money in 2007. How does one go about finding such concept. The starting point involves un-learning some things like technical analysis and adoption of new paradigms.

The major obsession of several methods used by technical analyst is timing the ownership of equities, but it involves very little thought about which equities to own, how to over weigh or under weigh them. If you are looking for edge, your first starting point should be study of market anomalies. The efficient market hypothesis (EMH) says that at any given time, asset prices fully reflect all available information.The Random Walkers proponents have convinced scores of investor that it is not possible to beat the market. However there have been numerous studies which have demonstrated existence of stock market anomalies.

Stock market anomalies are reliable, widely known and inexplicable patterns in returns. Many anomalies have been shown to persist in spite of their public knowledge. Anomalies come in all sizes and kinds, some offer very short term opportunities, some offer long term opportunities, some offer few percentage point edge, some offer several percentage point edge.

Some of the well known anomalies are:

1 Calendar Anomalies: Certain calendar periods have shown to be good periods to invest. Well known and public domain calendar anomalies are : January Effect, End of month effect, the weekend effect, the holiday effect.
2 Small Firm anomaly : excess returns can be earned by holding stocks of low
capitalization companies
3 Value-Line anomaly Higher ranked stocks earned higher returns.
4 Insider Transactions anomaly
5 PEADS ( Post earnings announcement drift): Over/Under Reaction of Stock Prices to Earnings Announcements
6 IPO's, Offerings, and Buy-backs
7 Low Price to Book/Sales/Earnings
8 Standard & Poor's (S&P) Index anomaly
9 Neglected Stocks and the Distressed Securities
10 Momentum anomaly

This list is not a comprehensive list. If you do exhaustive study , you will find several more anomalies. Basing your systems on proven anomalies is the starting point. Besides the public domain anomalies, there are number of other anomalies many traders have discovered and they are confidential. Over the years I have discovered few non public anomalies with substantial edge.

More anomalies you have in your trading arsenal, more confident you are and you are not worried about the market conditions. Making many of the anomalies work is the difficult part of the equation, but that is where your edge is.

So if you want to find the top stocks for 2007, one of your starting point should be exhaustive study of prominent anomalies. Finding and exploiting structural anomalies in markets is the path to profitability.