EC Why The Riskiest Stocks Have Been Vastly Outperforming Safe Ones

What does this mean for the risk-reward relationship?

I’ve written about this at length before but, to oversimplify, in financial terms it looks like this:

Risk-reward curve

With no risk, there’s no financial reward. As risk increases, financial reward increases, up to a certain point. After that point, risk becomes its own reward, a psychological reward, and financial reward decreases. And with the riskiest bets, you’re more likely to lose money than to gain any.

To maximize reward, you need to find that sweet spot between not enough and too much risk.

Conclusion

Prior to the pandemic, the conventional wisdom was to put all your money in index funds because there was no way you could beat the market. Now the conventional wisdom is that stockpicking is fun and profitable. Prior to the pandemic, the conventional wisdom was to minimize your losses by making safe bets. Now the conventional wisdom is you only live once, so go ahead and gamble.

We’ve seen how this has affected the factors I use to trade stocks. I believe that those factors will continue to work, at least for small caps and microcaps, and at least for a few more years. The behavior we’ve seen in the last four quarters is extreme, and soon some sort of equilibrium between the old behavior and the new will be reached.

But until that happens, all bets are off—except, perhaps, the riskiest ones.

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Alpha Stockman 1 month ago Member's comment

Great contrarian view.

William K. 1 month ago Member's comment

Quite interesting and certainly full of insight. The final evaluation that part of it is risk taken for the sake of risk is quite interesting indeed. That conclusion goes along with my assertion that at least part of the market movement is based on emotions. I do not say what kind because I don't know what is in people's heads. But clearly it is not fact based logic.

So it is nice to see that another has a similar opinion, approached from an entirely different direction.