Can You Predict Stock Market Movements? The Answer Might Surprise You

Isn’t this we always wanted to do? Correctly predicting stock market movements? Just imagine what would happen if we were able to do so 90% of the time.

We would become part of a really rich community of people.

Till today, and most probably going forward too, I would continue believing that it’s a waste of time to predict market movements. No one has been able to do it. And no one will be able to do it correctly on a regular basis. Warren Buffett has made a lot of money, but that is not because he is good at predictions. It is because he has some very strong mental systems and processes in place.

But I was just reading an article about political forecasting which made me question my prejudice about predictions. Please beware that I myself have made quite a few predictions in the past. Publically (2013, 2014) and privately. Some have helped me make money and others have taken it away from me. 😉

The question now is that is it possible to have a system for learning from market history that is not only programmed to avoid the most recent mistakes by companies, but also adapt the system to include learnings from current situations? Will we ever be able to push stock market forecasting ‘closer to what philosophers might call an optimal forecasting frontier? That an optimal forecasting frontier is a frontier along which you just can’t get any better.’

Predictions & Stock Markets
Predictions || Can You Do It?
Talking of stock market forecasting, there seems to be a systematic and fake overconfidence in the market forecasters. They think they know a lot more about future than they actually do. And the worst part is, when they say they’re 80 or 90 percent confident, the generally end up being 30-40% correct, which anyways is worse than a simple toss of coin.
But if we dig deeply, it is wrong to think that these people are in business of making accurate predictions. They’re in the business of flattering the prejudices of their base audience and they’re in the business of entertaining their base audience and accuracy is a side constraint. They don’t want to be caught in making an overt mistake so they generally are pretty skilful in avoiding being caught by using vague vocabulary to disguise their predictions. Also, these guys are here to make money at your expense. Period. They want you to trade as often as possible so that they can earn their living.
And I always feel that forecasters who are modest about their predictions are generally ones who have higher accuracy rates.
Coming back to the original discussion, we need to understand that to have a system of predicting with acceptable levels of accuracy, the big question is how to go about designing such a system? It would be a bad idea to take the best forecaster and submit his forecast’s as a system’s forecast. The system needs to be statistically more stable. Then the question arises as to how can one combine n number of individual predictions to become a part of an intelligent system? Can crowd’s intelligence be used to predict something as volatile as stock market movements?
A famous story will help you better visualize this concept of crowd intelligence –
There was a country fair in which 500 to 700 fair goers make a prediction about the weight of an ox. The estimated average prediction was 1,100. The individual predictions were between 300 and 8,000. Now when outliers were removed, the average came out to 1,103 and the true answer was 1,102. The average was far more accurate than all of the individuals from whom the average was derived.
Stock Market & Crowd Intelligence
Crowd Intelligence || Can We Predict Something, Together?
Personally, I am quite confident that it is highly unlikely that such a system can be made anytime soon. I have been a proponent of a small system of evaluating overall market valuation by using P/E Ratio, P/BV Ratio and Dividend Yields. But this one particular approach can just be one spoke of a larger ‘complete’ system of predicting. And who knows that the system being discussed might also use some technical indicators like 200 Day Moving Average.
But for now, enough of this academic discussion. I will keep you posted in case I am able to design such a system 🙂
Let’s leave with what father of Value Investing, Benjamin Graham has to say about predictions. And I can bet that after you have read what is written below this sentence, you would feel that whatever you have read till now does not make any sense. 🙂
“The investor can scarcely take seriously the innumerable predictions which appear almost daily and are his for the asking. Yet in many cases he pays attention to them and even acts upon them. Why? Because he has been persuaded that it is important for him to form some opinion of the future course of the stock market…. If you, the reader, expect to get rich over the years by following some system or leadership in market forecasting, you must be expecting to try to do what countless others are aiming at, and to be able to do it better than your numerous competitors in the market. There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully than the general public, of which he himself is a part.”

Do share your thoughts / predictions…

2013 Indian Stock Market Predictions

2012 is drawing to a close and Indian markets have given close to 25% returns this year. And just like past years, experts are coming out with targets like 21,000, 23,000 & 26,000 for Sensex. It seems that everyone is anticipating a bull market. And this anticipation is fueled by buzz words like Reforms, FDI, coming rate cuts, rising investor sentiments, etc.

So what are our predictions?

Before you close this website after reading our answers, we would like to tell you 2 things:

If a bull market is really coming, you will not listen to what we have to say. If markets correct next year, you will repent not listening to what we had to say.
So here is our answer:

We have decided not to make any predictions. It is irrelevant for long term investors like us. We will continue to invest in great companies and try buying them at really cheap prices.

So, have you decided to leave? Because you didn’t get that hot stock tip??

No?? …Then we will go ahead and tell you two really important facts…

Fact 1:

Indian markets are currently (December 2012) trading at P/E multiples of 19. And this is not cheap by any standards. You can check State of the Markets to get a snapshot of Indian market’s valuations. We have an analysis which tells that investing at current levels may not turn out to be a good bet for next 3-5 years. Anything less than 3 years does not interest us. Just check the table below:
PE Ratio & Returns Sensex
P/E Ratio of Sensex & 3-5 Year Returns
We are trading close to P/E multiple of 20. And average returns over 3 year periods are abysmally low at 4%. We won’t vouch for 5 year data as this number is skewed because of bull-run of 2002-07 (which may not be repeated during our lifetimes).

Fact 2:

We checked last 20 years’ data and found that 13 of those years gave positive returns. Out of these, 6 can be attributed to Great Indian Bull Run (2002-07). So, there were 7 ‘normal’ years of positive returns. These 7 years were followed by 4 years of negative returns & 3 years of positive returns. Surprised? Yes… its true. The probability of getting positive returns, just after an year of positive return is lower than that of getting negative returns.
We are sorry to disappoint those who were looking for hot stock tips for 2013. We continue looking for safe, stable, rock solid, cash generating machines. We don’t know what would happen in 2013. But we do know what we would do in either cases. If markets correct, we would buy more of these great stocks. If it moves up into the overvaluation zone, we would not buy. It is as simple as that. 🙂 But as it has been rightly said, successful investing is simple, but not easy.