The Magic Formula Investing Trading System

**nodoodahs** Fri Sep 08, 2006 7:35 am

The Magic Formula Investing Trading System
Joel Greenblatt is a system trader who considers himself to be a “value investor.” In the previous post on Defining a Trading System, I stated that every system answered certain questions, but some didn’t answer them very well. How does Magic Formula Investing answer the important five questions?

http://www.billakanodoodahs.com/?p=10

**blast_investor** Fri Sep 08, 2006 1:30 pm

Hi Bill,

Excellent write up on Magic Formula.

In your article, you stated that Magic Formula is "controversial". I actually do not see any controversial issues in this method.

"Value Investing" does not mean buy and hold forever. Value investors only hold value at cheap price. When the price is no good, or value is destroyed, value investors should sell even if the holding time is less than 1 year.

By the nature of value investing, most value stocks would need to be hold for more than 1 year. It is just the nature of this method, which is long term for most of time. But this method does not preach unlimited "holding time". The key is value, not holding time period. Therefore, I don't see any controversy on the "exit" strategy of "magic formula".

Ben Graham is farther of value investing. Graham also disclosed that his "exit" strategy was 2 years. Graham invested diversified bargain secondary stocks decades ago and he would wait for 2 years. If 2 years passed, and the stocks did not perform, Graham actually sold those dogs. So, from beginning of value investing, this method does have "exit" strategy.

**nodoodahs** Sat Sep 09, 2006 12:02 pm

The controversial portion (compared to most value investing methods) is that the exit methodology is not left to discretion. In most other value methods, exits are either not discussed, or left in very general terms.

JG sets it up very specifically - if it's not on the screener after a year, sell ... either just before a year (loser) or just after (winner). If it is still on the screener, there's an option to re-up for a year.

There's no selling in intra-year periods, no doubling down on losers, etc. The regimentation is what is controversial, or at least, exceptional, when compared to other value methods.

I intend to review many trading systems in light of the same five questions I used to define JG Magic Formula - you can find those periodically on my blog. If I review any other systems that style themselves "value investing" systems I'll post them here.