Failure to call the market is no fluke

It takes more luck than skill to beat the sharemarket, not that many traders are going to admit it. Or perhaps even realise. It turns out the real skill needed is in not being tricked by your own mind, as more studies are showing.

It takes more luck than skill to beat the sharemarket, not that many traders are going to admit it. Or perhaps even realise. It turns out the real skill needed is in not being tricked by your own mind, as more studies are showing.

Patience helps, too. It's well known - I'm sure I've mentioned it - that you just have to stick with a half-decent stock long enough to make money because profits will grow with the economy.

With a speccy stock, you'll do well or do your dough due to the extra risk. Unfortunately, if it doesn't keep you awake at night, forget thinking you can earn a sensational return. Unless, of course, you fluke it.

Which brings me to British-based Warwick Business School's study. It found flukes make our experts, well, experts.

After poring over three years of quarterly interest-rate and inflation forecasts quoted in The Wall Street Journal, Warwick's academics were astonished to find that an expert who got one quarter right then went on to become the worst at predicting the next one - or indeed, any others. Not just worse, but the worst. In the words of our academic friends, "those well-known experts who had pulled off a big windfall by going against the tide and winning were, over the long term, the worst at forecasting". So the very traits that prompt a brave prediction can produce "one hit among many failures".

It's a pity they didn't study brokers or fund managers, but you'd expect the same result. It's virtually inevitable - barring a lucky break - that the best fund manager one year won't be the next. In fact, they're likely to be one of the worst.

Where skill does come in seems to be less about expertise and more about tripping up the brain's built-in biases.

Take the self-defeating tendency to buy at the top of the market and sell at the bottom. The reason is feedback: everybody says values are going up, so they must be. Better hop aboard before you miss the bus. Never mind that a stock rising towards its peak price is riskier, with much further to fall potentially, than one that's dropping to its bottom.

In a study spanning five years, the Warwick mob also discovered that the more often that entries for 30 stocks in the Dow were viewed on Wikipedia, the more likely they were to fall. Yes, fall. The reason is that losing money hurts harder than missing an opportunity to make it. The pain of losing $10 at the casino is more intense and longer lasting than the thrill of winning $10, something psychologists have known for a long time. Our academics therefore concluded that it was the most worried who were consulting Wikipedia.

Just in case this result wasn't also a fluke, they looked up the number of page impressions of actors and filmmakers and found no connection to making money. All right, so they're academics.

Another classic is experiments that show we're more prone to act on information that confirms our view than something that challenges it. There's even a name for it, "confirmation bias". Yet another recent study shows investment bankers, like everyone else, underestimate the odds of a catastrophic loss. And given the choice of half-a-dozen investment options for super, you'll either do nothing or just go with the default option. Go on, admit it.

Sorry, neither is likely to prove the best choice. So don't blame the markets any more. It seems we're our own worst enemy.

Twitter @moneypotts

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