A stock trading in the future will have zero downside if it trades for $1, because it will trade for zero dollars at that time, says Professor David Lafferty of the University of Queensland in Australia.
“It will be worth nothing, if you ask me, for $5, or even $1,” he said.
Prof Laffercy and colleagues have found a trade that is likely to have zero-downturn returns of about 8 per cent.
That’s a large enough margin to make the trade profitable.
It also gives a lot of leverage.
“This is a big deal,” Prof Laffles said.
“There are a lot more trades that have zero returns than there are profitable ones.”
The idea of zero-downside stocks emerged from a paper by two economists, published in 2007.
The paper is called The Stocks That Have Zero Downturn Returns, and is based on the idea that if you have a good enough idea of how much you have in the market, you can make an educated guess about how much it will cost to buy it at that point in time.
The idea that a stock market will have no downside, or zero returns, has been around for some time, but is now gaining traction.
A paper from 2007 by the economists at Princeton University and the University in Cambridge estimated the probability of a stock trading at zero in the past 10 years.
Their paper, which was accepted for publication by the Proceedings of the National Academy of Sciences, was based on data from the National High School Student Loan and Job Search Survey.
The authors used that data to calculate how many of the stock market’s 100 largest companies had been profitable since 2008.
They found that of the 1,749 stocks that had traded between 2008 and 2015, only 12, or 1.5 per cent, had a negative net worth.
That suggests that most of the negative net-worth stocks were in the $5 to $10 range.
The other 1,5 per on average, were in between $10 and $20.
The researchers estimate that of those 12, about three-quarters were still profitable.
They suggest that investors should pay close attention to how a stock performs in the near term.
“These numbers are an indication of how successful the market is and that the markets ability to absorb losses is very limited,” Professor Lafferhood said.
He said the idea of a zero-net-worth stock would be a very useful one to think about in the context of the recent US stock market crash, which has led many investors to sell their stocks.
The recent crash in the US stock markets was due to a “toxic” mix of short-term speculative trading, which led to the collapse of the housing market, and a collapse in the economy, he said, and the lack of strong, long-term growth expectations.
He suggested that investors could take advantage of a different way of looking at the market: by thinking about how they could be in a position to make a profit in a short time.
“What you want to do is take the risk off the stock and make it a long-lived asset, and then you have the opportunity to take the short-sellers out and make them make money,” he explained.
Professor Laffley has published two other papers, one published in 2006 and the other in 2010, that were based on his work.
Both involved the idea “that you can use your knowledge of markets history to predict how well a stock will perform in the next few years”, he said of his new paper.
The latest paper, published last week, also looked at the probability that a trading stock will fall to zero in five years.
It found that only 12 of the 30 largest stocks in the country had had zero net-net worth in the 10 years to March 2016.
That was an average of 2.5 percentage points.
Prof Nils Pohjola, from the University College Dublin in Ireland, said that Prof Lachley’s research was very impressive.
“He has a good understanding of how markets work, and he is able to put the theory together, and put together a pretty good idea of what it would take for a stock to have a negative market-cap, or a zero net worth, for the next five years,” he told New Scientist.
“That’s very impressive, in terms of his theoretical thinking.”
Prof Pohju said the theory is quite different from a typical textbook model.
“The basic idea is that you need to have the fundamentals in order to make any predictions about the market,” he added.
Prof Puhjola said there were many different ways to predict what the stock markets price will do in five or 10 years, and that his work “was the first to really use that framework”.
“I’m pretty much in the same boat as David Lachhood,” he concluded.