The True Nature Of Predicting

Jon Boorman has an interesting piece on the futility of making market predictions.

Long time ago, Phil Pearlman wrote an insightful post, pointing out the upside of making an outrageous prediction.

Here’s how it works.

If I make an outrageous prediction or label a prediction outrageous and I am wrong, I respond to criticism like this:

“Well, I said it was an outrageous prediction.”

This discounts my responsibility for being wrong to some degree. But if I am right, I will say,

“look how brilliant I am. I made an outrageous prediction and it was dead on.”

Outrageous predictions are used to manage impressions. One defers responsibility if wrong and gloats incessantly if right.

It is a manipulative gambit.

People, who make outrageous predictions know exactly what they are doing. Their potential reward is much bigger than the risk they are taking of being publicly laughed at. Many people have made a career by being right once about a major event that nobody expected (usually a big market correction).

Predicting and speculating have a lot in common, but they are also very different. By definition, predictions are about dealing with factors, you have no control over. When you speculate in the stock market, you also don’t have control over which one of your trades will be profitable and for the most part how profitable it will be. You could improve the odds, but you can’t impact the outcome of each individual trade. When you speculate, you put your own money at risk. You could be right for the wrong reasons and make money (lucky). You could also be wrong despite having an edge and still lose money (no approach has 100% success rate). Since you have very little control on some of the variables that impact your results, it doesn’t really make sense to speculate about only one outcome, because in this case you are getting prepared for only one outcome. The solution – You develop several different scenarios and you prepare for each of them.

A) You could be wrong

  • where is your stop loss?
  • How much of your capital are you going to risk?

B) You could be right

  • Where are you going to exit so you maximize not only your individual return on one particular trading idea, but your overall capital return, which takes into account opportunity cost.
  • Are you going to sell on strength, on weakness (when the trend for your time frame is invalidated).
  • Do you have a time stop in place – it assures that you don’t keep you capital in a non-performing assets.
  • Do you have a plan where to add to you position? One of my favorite market insights from George Soros says that “it doesn’t matter if you are right or wrong, but how much money you make when you are right and how much money you lose when you are wrong”.