The Truth about Predicting Market Direction

Few traders earn a living by correctly predicting stock-market direction consistently. Every prognosticator is right about half the time, and anyone who can get it right near 60% of the time will be very profitable.

If you plan to make money by timing the market, I wish you the best of luck. You may become one of those very successful traders. But, I urge you not to count on achieving success that way.

I believe that trading reduced-risk, limited profit, hedged option positions offers the average trader the best opportunity to beat the market because there is no major prognostication required. If you are familiar with my writing, you know I believe that there are several strategies, when managed conservatively, that can increase the probability of making money. However, the main factor that determines profitability is not the strategy, but the discipline of the trader to keep risk in line, not violate personal trading rules, and most of all, to truly understand what he/she is doing. Please do not believe that anyone can open an options account and expect the cash to come pouring in.

Returning to the topic of market prediction, here is an excerpt from a blog post by a former star (or, in the opinion of some, a villain) stock market analyst turned blogger, Henry Blodget. This is from the Business Insider web site.

I Don’t Know What The Market Is Going To Do!
Henry Blodget

I recently expressed a cautious view of the stock market.

Specifically, I think the odds of a sharp decline (“crash”) are increasing. And I think the odds are very good that stocks will provide lousy returns from this level over the next 7-10 years.

Well, most people are bullish about the stock market these days (because the market has done so well for so long), and anytime you say something bearish when most people are bullish, you get pelted with rocks and garbage.

Specifically, you get told:

You are brain dead
You are not a money manager
You don’t know what the market is going to do

I would like to respond to each of these assertions.

First, my successful commute into work today would suggest that I am not yet brain dead (lots of cognitive decisions and motor movements!), but anything’s possible.

Second, I actually am a money manager! I manage money for one client. I know this client’s objectives, risk tolerance, and investment time horizon very well. And I try to do an excellent job for him. (That client is me.)

Third, yes, I do not know what the market is going to do.

In my defense, however, I will point out something:

No one else knows what the market is going to do, either.

Fifteen years ago, when I was a Wall Street stock analyst, I initially assumed that there were smart people who actually knew what the market was going to do. For close to 10 years, I kept waiting to meet these people. As I worked my way up the food chain, and gained more market experience myself, I began to realize that the smart folks I initially assumed knew what the market was going to do were wrong about the market just about as often as everyone else. When I learned that, I assumed that I just hadn’t met the right smart people yet. So I kept working up the food chain. And, eventually, when I became a famous stock analyst myself, I got to meet just about everybody, including some of the most legendary stock-market wizards in history. And what I finally realized was that even these folks, as super-smart as they were, didn’t know what the market was going to do. They were right slightly more often than all the thousands and thousands of average smart people — and, importantly, they were willing to bet big when they thought the odds were very much in their favor. But they didn’t know what the market was going to do.

This was a revelation for me.

When I finally realized that no one knows what the market is going to do, I developed a very different philosophy about money management. That new philosophy — own a diversified portfolio of low-cost index funds and re-balance when the asset weightings get out of whack — was more humble, simpler, safer, and wiser than my prior philosophy (stock-picking, market timing). And it has also been vastly more successful.

When you finally accept and embrace the idea that no one knows what the market is going to do — when you stop looking for that one brilliant fund manager or advisor or analyst who is finally going to make you rich without accidentally making you poor — you will be able to easily outperform the vast majority of other investors, including professionals, with a lot less time, stress, and hassle.

But, importantly,I am not selling my stocks or going short the market…

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