If you’ve been paying attention to business television and social media recently, you’ve probably noticed a large jump in predictions warning that the market is going to undergo a dramatic correction. Some of these predictions are based on charts and some are based on macroeconomic concerns.
These predictions are well-meaning, and some thought goes into them. However, they are mostly useless and a detriment to good trading.
The biggest problem with predictions is that they create an expectation. We all want our predictions to be correct, and therefore we are constantly looking for information that will confirm our pre-existing bias. This is known in behavioral economics as data mining. We develop a thesis and then mine for data that will support it and minimize the evidence that doesn’t.
It is good to have conviction, but it is better to have an open mind.
Wishing, Hoping, Dreaming
One form of prediction that I find particularly unhelpful are price targets. We all know that market conditions are constantly changing, yet we set price targets without regard for the great likelihood that conditions may be totally different next week.
The appeal of a price target is easy to understand. We buy a stock, set a price target, and then go to the beach while we wait for it to hit. It relieves us of the burden of having to deal with the stock at all. Since targets are obviously so effective, we don’t need to do anything else.
The main reason people like targets is because they like to wish, hope, and dream. “I’m going to make $X when this price target finally hits,” they think. The biggest problem with a price target, however, is it creates the illusion that you don’t have to continue to manage a trade. The price target is used as evidence of great fundamentals even after conditions have shifted. That can be a source of tremendous losses for many traders.
Predicting what the indexes are going to do is just another form of price target and a staple of the business media. The great majority of programming we see on financial TV is dedicated to experts anxious to tell us, with great confidence, what will unfold in the months and years ahead.
The main reason these predictions are so common is that they are made without any real consequences and are encouraged for ratings. These pundits often have no money on the line, and you can bet that the predictions go out the window if they actually do have money invested.
The biggest problem with predictions is that they create an expectation.
If you make your living by trading the market rather than talking about it, you quickly realize that if all you do is make predictions, then you are very likely to have very poor results. The main problem is that predictions do not take into account “risk.” When you have real money on the line, you have to consider the consequences of being wrong, and that makes most predictions just downright foolish.
A great example of a trading methodology that does not rely on the sort of predictions so many believe are the key to trading is the CANSLIM system. CANSLIM was developed by William J. O’Neill, who founded Investor’s Business Daily.
The CANSLIM system relies heavily on trading with the market trend, but it doesn’t try to predict what the trend might be. IBD changes its market outlook in a highly reactive matter. Only when there is a combination of technical follow-through days, and increased volume does the system declare an uptrend. It takes a series of distribution days and technical breakdowns to put the market into a correction.
There are no predictions about what the market might do six months from now if the Fed hikes interest rates five times. There is no speculation about where the S&P 500 will be many months in the future.
The CANSLIM system is based on reacting to market conditions as they change rather than trying to predict what might happen to the market in the future.
When you have real money on the line, you have to consider the consequences of being wrong.
Real traders focus on reactive strategies that limit risk and increase the chances of making money. The primary difference between predictions and reactive strategy is flexibility. Rather than focus on one particular outcome, an astute trader considers a wide range of possible outcomes and is ready to move as conditions shift.
Embrace the Unknown
Grand predictions lead to being grandly wrong if you lack flexibility. Effective traders can’t afford that mistake. If you want attention, then make big, bold predictions, but if you actually trade that way, the cost is far too high.
The prediction business is booming right now because everyone has an opinion about the impact of the highest inflation in 40 years and the most hawkish Fed in decades. It is natural to contemplate how this will unfold, but it is a mistake to let those predictions drive your short-term trading.
The market is not going to do the simple and logical thing that many think it will do. It is going to have all sorts of twists and turns along the way, and if you are dogmatic about making predictions, you will be unable to navigate them effectively.
Embrace the idea that you don’t know what the future holds. Deal with what is in front of your face, and be prepared to react and reposition as conditions change.
Over a long period of time, aggressive reactions will always beat predictions. Just look at the CANSLIM model if you want proof.