Investopedia: Trading With Market Anomalies

It is generally a given that there are no free rides or free lunches on Wall Street. With hundreds of investors constantly on the hunt for even a fraction of a percent of extra performance, there should be no easy ways to beat the market. Nevertheless, there are certain tradable anomalies that seem to persist in the stock market, and those understandably tend to fascinate many investors.

While these anomalies are worth exploration, investors should keep this warning in mind – anomalies can appear, disappear, and re-appear with almost no warning. Consequently, mechanically following any sort of trading strategy can be very risky. (Find out why little companies have the greatest potential for growth in Small Caps Boast Big Advantages. For another article identifying the same principles, read Why Warren Buffett Envies You.)

Small Firms Outperform
The first stock market anomaly is that smaller firms (that is, smaller capitalization) tend to outperform larger companies. As anomalies go, the small firm effect makes rather a lot of sense. A company's economic growth is ultimately the driving force behind the performance of its stock and smaller companies have much longer runways for growth than larger companies. A company like Microsoft (NYSE:MSFT) might need to find an extra $6 billion in sales to grow 10%, while a smaller company might needs only an extra $70 million in sales for the same growth rate. Accordingly, smaller firms typically are able to grow much faster than larger companies and the stocks reflect this.

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