STOCK market investors want to believe that prices follow a logical and well-ordered pattern. If that is true, then all that is necessary to make good profits is to figure out what the pattern is.
If prices go higher because of good company earnings reports, then all you need to do is simply follow the earnings reports. If prices go down on bad economic news, then all we need to do is listen to when government releases the official numbers.
But maybe the analysts that use charts and price movement patterns are the ones that have the answer to winning in the stock market. Stock market investing then is a simple operation. Weather forecasters and meteorologists know that certain cloud formations can accurately predict when it is going to rain and when there will be sunshine. So therefore, learn the patterns and you can predict the future.
Why then is it true that most investors are not maximizing their investing profit potential and taking large losses than in hindsight seem very avoidable?
There are several mistakes that investors make that repeatedly causes low wins and large losses. The gambler’s fallacy is the belief that if something happened frequently in the past, it will happen less in the future. If you flip a coin and it comes up ’heads’ 100 times in a row, the gambler’s fallacy is that the next time it will be ‘tails’. But each coin toss is independent of the other and the odds are always 50/50 no matter how many times one side has come up.
While stock market price movements are not mathematically certain like the toss of a coin, we have the desire to believe that a mathematical formula can be applied and then create a gambler’s fallacy.
How many times have you heard it said that the stock market is due for a correction? Many supposedly valid reasons are given for that assumption. Prices are too high. Valuations are too expensive. Prices need to consolidate.
That is a variation of the gambler’s fallacy. In late 2011 through early 2013, the Philippine Stock Exchange Composite (PSE) Index closed higher for 16 out of 19 months and closed higher for 8 straight months. No, the market was not due for a correction because assuming a correction is necessary is to also assume that the coin toss will not result in ‘heads’ 100 times in a row.
The problem is our basic understanding of the stock market price movement. The most basic assumption for price movement is, for example, that there are more buyers than sellers and prices go higher. That would seem to make sense but only if all buyers and all sellers are acting for the same reasons. Yes, buyers only buy if they believe that prices will go higher. Sellers sell for many reasons other than a belief that prices will go lower.
But even if that is true, it is still an over simplification.
A good computer program can consistently and continuously beat the best human chess players in the world. The same is true for Othello, Scrabble, backgammon and even poker. Companies that make stock market trading software would like you to believe that their programs can do the same thing for the stock market. Studies have shown that these programs succeed only because they take advantage of trading mechanics and do not ‘predict’ what stock is going to be higher in a week the same way rain is predicted.
Every stock market trading book in effect acknowledges the belief that stock price movement cannot be accurately predicted. That is why much of the books are devoted to ‘strategies’ rather than predicting.
No computer program can consistently and continuously beat the best human player of the ancient Chinese game of Go or Weiqi. That is because after both white and black pieces have made their first move in chess, there are 400 possible moves in the next round. After the first move in Go, there are 129,960 possible moves in the second round. It is almost the same for the stock market.
In the first six months of 2014, the biggest PSE gainer was Sinophil Corp., up 430 percent. The biggest loser was PhilWeb Corp., down 43 percent. Which expert or guru on January 1, 2014 predicted either of those price changes?
The stock market is a game, not a science.
E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter @mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.
2 comments
I belief so Mr. Mangun. Unpredictable, very unpredictable indeed.
unpredictable..that’s what makes this stock market exciting..now i have to learn more…