Stock Market Prediction – Fact Or Fiction?

Is stock market prediction fact or fiction? Stock market prediction is mostly a fiction created by the big money people who sell dreams though it does exist in some forms.

That is truly a multi billion dollar question. People have been analyzing data for a long time trying to develop predictive measures of the stock market.

In most instances they develop something that gives them a slight edge for a while but eventually returns to the normal performance or in some cases presents very large drops as the model breaks down.

Notice I mentioned a model. Scientists develop a model that fits the actual performance to a mathematical equation. They take a set of data and try to determine what outside factors cause the market to rise or fall.

It is a very large business with billions of dollars at stake. Lehman Brothers went bankrupt when their statistical model didn’t match reality. It has happened before and I am sure it will happen again.

Stock market prediction is a business that goes through cycles. When things are stable, a model can be developed that matches the performance of the market. More and more people develop similar models until a large portion of the available money is all taking one side of the trade.

This creates an unsustainable condition that eventually takes a dramatic change for the worse. Once the market begins to change, the statistical models each company has developed breaks down. Some do so quickly which causes a cascading effect through the companies all running the same type model.

This dramatic shift causes a tidal wave to ripple through the companies. Suddenly trades have to be taken off in a very rapid fashion. Due to the large amount of money in these trades the market is not able to absorb them in a smooth and consistent fashion.

Since some of the models are built around using leverage to amp the returns, the effects are more prominently felt in those companies. They eventually reach equilibrium but cause chaos in the markets until things stabilize.

The stable periods are when models work effectively. They give a huge advantage to the company that develops an accurate model early on. They also can provide for a long period of time when outsized returns are possible.

The decades of 1980 and 1990 show the dramatic rises that can happen in stock market valuations. When fundamental and cyclical events line up to create a synergy, markets can rise dramatically and consistently.

The transition periods like 1964 to 1984 are when models tend to break down. Because the market isn’t stable it makes creating an accurate stock market prediction nearly impossible. Those transition periods (I guess two decades qualifies as a transition though it is a very long time) make stock market prediction a tough sport to play.

See Also : Should you Be in The Market Right Now?