A question that I am most frequently asked and one of the most difficult one is “what do you think will happen in the market tomorrow?” My family has a lot of doctors, they say one the most difficult question they face is “what is the prognosis in my case?” This is a tough question because it is asking someone to make a specific prediction and predictions are almost always wrong. Let’s see why:
Predictions are extrapolations of the data based on statistics. Extrapolation is based on averages, and averages do not represent the population. Let’s take an example, if we know that the average marks in a class is 67.5, it does not mean that most students got that mark. It is possible that no student got 67.5. Also most students will have marks that are different from 67.5. Average is a good measure but it in itself tells us precious little. Since predictions are based on averages they tend to be more wrong than right.
Billions have been spent on predicting weather and it is still not accurate (else weather predictions will not continue to be the butt of jokes). This is because of the number of variables that need to be factored in for predicting weather makes it very difficult.
Most doctors believe that each patient is unique and the prognosis will be different for each one. Instead of asking for a specific prediction, the patient may be better off asking about the range of possibilities for their conditions so that they can get information which will help them be better prepared to deal with their case.
Similarly, stock market predictions are tricky because they are based on a host of parameters like the performance of specific company, state of the economy, sentiments of investors (which, I believe, is almost impossible to predict) etc.
We believe predicting the outcomes in a stock market consistently and correctly is almost impossible. People may get a couple of calls right but there are none who have done this consistently over a period of time. This does not mean that investing cannot be a profitably activity. We just need to have a different mindset.
When we prepare our children for exams, we don’t try and predict the questions they will be asked in the exam. We try and get them prepared for a variety of questions that they may encounter. The belief here is that the preparation will enable them to tackle any/most questions they face in the exam. We believe the same thought process holds good for investing. Investing is all about preparation for various scenarios rather than prediction of specific outcomes.
People with investment mindset understand that the markets are inherently unpredictable and markets fluctuate between the extremes spending very little time at the averages. People with an investment mind set have the humility to realize that they are not the smartest people in the market, but they also have the wisdom to understand that to in win in the market they need not outsmart everyone. They take a disciplined approach to investing so that their portfolios are able to withstand the vagaries of the market and have an opportunity to benefit from them.