How Predictable Are Financial Markets?

How Predictable Are Financial Markets?

Are financial markets truly predictable?

 Is it possible to figure out how the market will behave in the future based on its known past performance?

It’s not a secret that when it comes to financial markets, there’s too much at stake. The stocks of major companies, pension funds, state obligations, the entire economy is hinged on the financial markets. However, when it comes to the individual investor, his interests and concerns are usually much more down to earth. What interests him is whether a particular asset, be it a stock or commodity, will go up or down.

 

what exactly makes markets predictable or not

There’s a lot of debate on what exactly makes markets predictable or not. Sometimes it’s pinned down to individual abilities. Indeed, by analyzing publicly available information such as chart data, financial reports, economic and regulatory events, general market sentiments, the investor can gauge the asset’s performance and make predictions about its further growth or decline. Depending on how accurate his predictions are, his net worth will either go up or go down.

predicting the market

But predicting the market for the purpose of speculative trading is not that easy. The price appears to be random and chaotic, not really following any discernible rules and patterns. This is the chaotic environment that only the most capable of traders can flourish in. Sometimes, armed with a set of technical indicators and other times relying on their own intuition and skill, the end goal is always to have more gains than losses. Because for a speculative trader, losses are inevitable and impossible to avoid completely. Consequently, the wise trader tries to minimize his losses, offset the risk, and control his emotions that can easily get in the way.

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Less risk with a long-term investment

When it comes to solid, long-term investing, there’s much less danger of being overwhelmed by speculative noise and dangerous fluctuations. The factors accountable for the asset’s future movement are much easier to spot. Supply and demand are more transparent, which plays a big role in investing: it’s supply and demand that determine the market’s movements. A lot of serious investors who built a massive wealth did it by holding long-term stocks and assets rather than by short-term speculation.

However, it hard to underestimate the power of the unpredictable. Oftentimes, it changes things dramatically.

The Black Swan Theory

One of the theories developed by Nicholas Taleb, a famous economist, investor and financial critic, was the theory of the Black Swan. It has important implication for financial markets in a sense that the future is not predictable as it has been often seen. Traditional financial analysts typically considered a limited set of possible outcomes and thus neglected the bigger picture. Something that is extremely unlikely to happen does not necessarily make a negligible impact. Unpredictable, ultra-rare events can be so turbulent as to completely overturn all the established notions of financial markets. One of the reasons why such events are neglected so much is precisely because of their name, they’re rare. It’s easy to extrapolate the patterns of the past to the future. In reality, it’s not necessarily the case.

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