Learn About the Markets

Book Review: Outperform the Dow

Outperform the Dow
Using Options, Futures, and Portfolio Strategies to Beat the Market
Gunter Meissner & Randall Folsom
John Wiley & Sons

The boom in the online investing world has also produced a boom in the investing book market. Many of the books we see for review are either too esoteric for most people or too basic. "Outperform the Dow" is one book that is right in the middle, providing useful information for intermediate and experienced investors who want to expand their approach.

Distinct Chapters

One terrific aspect of this book is the division of material into chapters. Although the entire book is aimed at the theme expressed in the title, each chapter is independent.

This type of division makes the book useful airplane reading, or a good reference book. It isn't necessary to read the entire book to find an interesting new technique.

Most of the chapters start with a short, but clear, explanation of the security or strategy. Then a list of the variety of methods and approaches for each security is listed. The explanations are the best part of this book. The listed methods, which are tactical implementations of the strategies, are useful introductions, but are not deeply examined.

Brief Summary

Here is a quick summary of the type of information in each of the seven basic chapters:

Dow History: A fascinating historical summary of the Dow Jones Industrial Average, including a list of the original 12 stocks and their fate. Only General Electric still exists from the original Dow Jones Average of 1886, when the Dow was at 38. And though the Dow reached 380 in October 1929, after the crash, it did not recover to that level until 1954, 25 years later. Something to remember when people tell you that stocks always go up.

Technical Analysis: The chapter actually covers numerous methods of mathematically predicting future prices. But the strength is its approach to technical analysis (TA). For someone unfamiliar with technical analysis, the summary is a good overview. For experienced technical analysis traders, the methods are probably too basic. But for investors looking for a 24-page intro to TA, this is it.

Portfolio Strategies: A good coverage of the variety of Dow based theories, including the "Last Year's Winners," "Fool's Four," and "Smooth Risers." Notably missing is the "Dogs of the Dow" approach, which was extremely popular in 1997 and 1998, but proved inferior in 1999, and is now out of favor. It remains to be seen whether or not that is the fate of other listed strategies. 

Futures: The strength of this book is its basic definitions and explanations of the variety of derivatives. This is a great 25-page explanation of futures. If you aren't really sure what a future is and how it works, this is a good beginning. The next 12 pages list seven different strategies using futures, which glosses over the details of some of them.

Options: Again, another good chapter describing the basic operation and uses of options. Particularly useful are the graphs that illustrate in-the-money and out-of-the-money concepts, along with how a premium declines as the expiration date approaches. Five different methods of playing options are mentioned.

Volatility Strategies: Volatility is the application of statistical theory to price movements. Usually, if you buy a book on volatility you need a math degree once you get past the first chapter. The explanation of volatility math is remarkably handled in just 10 pages. This doesn't mean volatility approaches are good investing strategies, but if you want a good beginning to the approach, this is it. Five methods are listed.

Exotic Option Strategies: Now you get into strategies that the ordinary investor almost never has the opportunity to use. Digital options, barrier options and quanto options are all derivatives that are aimed at institutional investors, usually orchestrated by investment banks. Nevertheless, if you have never heard of them it's interesting to see how others use them.

Best For?

Overall, "Outperform the Dow" is a good starting point for someone who is experienced in the market, but primarily with straightforward buy-and-hold approaches. It's not for beginners.

Most of the strategies are best applied for investing premises, not trading premises. The techniques are primarily aimed at "juicing" portfolio returns. These aren't methods for running a portfolio solely built on options.

Strengths

The overall strength of "Outperform the Dow" is the brief introduction to the variety of other securities in the market. If you have heard of futures and options, but aren't really sure how they are used, this is probably the best introduction you can get.

Another strength is the bibliography at the end of each chapter. Although the books are only listed, with no analysis of them, the comprehensive listing gives you something with which to head off to the library or the online bookstore.

Critiques

What's missing? The best, in our opinion, approach to "juicing" the returns of a large-cap portfolio is writing covered calls with stop losses at the size of the premium. This approach only receives two short paragraphs in the chapter on options. We feel it could easily have been the entire topic of the chapter on options, if not a separate book unto itself.

Experienced investors also may find that while the book covers basic instruments and their characteristics, coverage of specific methods can be shallow. For example, Method 12 in the options chapter simply boils down to buying calls in January and puts in October because the Dow historically rises in January and falls in October. No discussion is made of whether to determine whether the current year is the exception to this historical pattern, or whether current pricing already reflects the January or October effect.

The book is also fairly uncritical of the methods presented, with little analysis of how to "kick-the-tires" of a method. For example, reading TA charts is described as if it works all the time. In general, TA only works in the absence of new information. With technology stocks a time period without new information is rare indeed, which has driven TA players to smaller and smaller time periods for action.

Summary

"Outperform the Dow" is a great introduction to new concepts, particularly for investors with a fair amount of experience. If your objective is an easily read overview of the basic derivatives and their uses, this is the best introduction we have seen in a long time. "Outperform the Dow" won't hand you the keys to a magical method to profits, (nothing will), but it will, in a short time, get you informed about the basic techniques widely used on Wall Street.

Robert V. Green