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The Little Book of Trading: Trend Following Strategy for Big Winnings by Michael W. Covel

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Appendix A

Getting Technical

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What is Capitalism Distribution?*

THE STOCK MARKET YIELDS A MINORITY OF VERY LARGE winners, a majority of below average returns, and a larger than expected number of dramatic losers. This phenomenon is capitalism Distribution, and it can be observed in virtually any market, on any continent, across any decade. Capitalism is brutal, lumpy, and winner-take-all.

In Chapter 10, we met Eric Crittenden and Cole Wilcox. The database they use to find winning stocks covers all common stocks that traded on the NYSE, AMEX, and NASDAQ since 1983, including delisted stocks. Stock and index returns were calculated on a total return basis (dividends reinvested). Dynamic point-in-time liquidity filters were used to limit the universe to the approximately 8,000 (due to index reconstitution, delisting, mergers, etc.) stocks that would have qualified for membership in the Russell 3000 at some point in their lifetime. The Russell 3000 Index measures the performance of the largest 3,000 U.S. companies representing approximately 98 percent of the investable U.S. equity market. (See Exhibit A.1.)

Exhibit A.1 Total Lifetime Returns for Russell 3000 Stocks, 1983–2006

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Exhibit A.2 Compounded Annual Return, 1991–2008

An investor who owned 95 percent of all stocks, but who missed ...

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