Trading is Not About Prediction

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Profit Without Predicting the Market

Additional knowledge accumulation is not always beneficial when trading financial markets because some information can make us more ardent in our views and opinions, so we make bold predictions that turn out wrong. And incorrect predictions can be costly when real money is on the line, especially when we take positions against the prevailing price movement and in anticipation of a quick and sharp change in price direction, but then the reversal never happens.

Key Takeaways

  • Predicting the market is challenging because the future is inherently unpredictable.
  • Short-term traders are typically better served by waiting for confirmation that a reversal is at hand, rather than trying to predict a reversal will happen in the future.
  • Viewing price action as a series of waves is an alternative to predicting future price moves.
  • Establishing significant points to buy and sell should be based on what price is actually doing, rather than what we expect it to do.

Investors, especially short-term traders, are usually better off waiting for the movement in price to confirm a trend or reversal rather than try to predict what is going to happen next. Section two of this article looks at some ways we can rework our thinking to gain a better edge. The first section looks at the reasons why predicting can be a problem.

The Prediction Problem

  • The future is uncertain.No matter how good our analysis is, it is only as good as the information that is available right now. We cannot know for certain what will happen tomorrow. Analysis in regards to likely movement in the future is done with the idea of “all else being equal.” This means that we assume a stock will go up based on a trend if things remain as they are right now.
  • We can’t predict all contingencies.While on some days (in fact, many days) everything does remain equal, there are always days, weeks, months, or even years that defy the odds. During these times, predicting can be especially dangerous if expectations turn out incorrect. For example, predicting that something will go up when prices are falling can cripple a trader’s finances, especially since we can’t know for sure how the market will react to further news or information that may become available. When prices are falling, even good news may not push prices substantially higher, and when prices are rising, even bad news won’t necessarily have a long-term negative effect on price.
  • If the overall market moves higher, this does not mean a stock will also move higher.Analysis of individual securities is often based on the sentiment of the overall market. This can mean a trader expects one stock to rise because the market is rising, or vice versa. This does not always occur, especially in shorter time frames. Unfortunately, an alternative scenario also occurs where a trader expects one stock to outperform while the rest of the market continues to fall. Traders must be aware of market dynamics as well as individual stock dynamics. Either way, the end result is that we want to be trading in the direction of current cash flows, not against them, whether it be in the overall market or individual securities.
  • Predicting that a particular stock should move higher is vague, and the investment decision will rarely include a profit or stop-loss exit point.While not always the case, inexperienced traders predict that their equity positions will rise and assume that they will be able to get out near the top if they are correct. In reality, such a vague plan rarely works out. Therefore, all traders must have a plan for how they will enter and exit a trade, whether the trade results in a profit or a loss.
  • The holding time for stocks has decreased along with increasing volatility.Stock market volatility has increased over the years, while the holding period for securities has fallen off. Buying and holding is still a viable strategy if the method is well-devised (as with any trading method), but due to limited capital, buy-and-hold investors must be aware that volatility can reach very high levels and must be prepared to wait out such periods. Active traders trading on shorter time frames should trade in the direction of price movements given that volatility has increased, and even short-term moves can sustain overbought or oversold levels for extended periods of time.
  • Statistically, prices rarely move in straight lines for long.Predictions are often based on strong emotional feelings—the stronger the feeling, the stronger the trader may expect the price reaction to be. Thus, the trader assumes that the stock will fly in the anticipated direction in a straight movement, leading to large profits. When we look at all the securities in the world and then factor in time variables, having a position right before a major move is very unlikely, statistically speaking. Traders are far better off trading the averages and trading in the direction of price movements to gain profits as opposed to looking for one trade or stock that rises aggressively in their favor in a short period of time.

Alternatives to Prediction

Given that we now understand trying to predict a turning point in the market can be very costly, one asks, “If I can’t predict, how do I make money?”

Whether attempting to predict the market or not, generating consistent profits from short-term trading is exceedingly difficult, even for the most experienced investor.

The answer is that we follow the price, and we can do so by following the guidelines below. This is not an exhaustive list of market dynamics, but understanding these should help traders find themselves more on the right side of the trade than on the wrong side.

  • Prices fluctuate in waves.Looking at any chart after understanding the points above, all traders must understand that prices move in waves on all time frames. This means that, even though prices may fall, traders don’t need to panic and jump out of positions as long as the longer trend is still up. However, they still should have an exit point in case prices are no longer in an upward trend in their time frame. Short-term traders can participate in each of these waves but must remain nimble and not be tied to one direction when doing so. To predict that prices will move in only one direction is to disregard the factual tenet that prices move in waves.
  • Don’t assume support or resistance will hold.A very common misconception is that support or resistance will hold, or that a break of these levels will cause a substantial breakout. The position traders have often determines what they predict will occur. What traders need to realize is that support and resistance levels are simply important price areas. Making assumptions that a breakout will occur or that a level will hold off a further move is an attempt to predict the market. Rather, traders should watch what occurs around these levels and then enter as momentum moves in one direction or the other. If resistance holds and prices retreat, then a short position could be entered, for example. If a breakout occurs, then trade in in the direction of the breakout. Keep in mind, false breakouts occur, and (to repeat) prices move in waves. Don’t be tied to a position simply because a position showed a profit for a time.

It is better to think of support and resistance as pivot points for price and areas to look for entries and exits. By doing so, we are not predicting that something will occur or going against the prevailing price movement. Instead, we enter into the current price flow. This makes trading “matter of fact” as opposed to emotional. We have picked out important levels that will help us isolate the price waves a market is moving in. Then we can take a corresponding position as prices react at these levels.

The Bottom Line

Predicting the markets can be dangerous and, ultimately, predictions are not needed in order to make money trading. By realizing that prices move in waves and that we should not predict whether important levels will hold or be broken, we can enter trades at significant points but in reaction to what price is actually doing and not what we expect it to do. Traders benefit by remaining nimble in their positions and not being tied to a particular direction because of a prediction.

Trading is Not About Prediction

Sitting at dinner last night with several friends I was asked my thoughts on the stock market — a question I get asked numerous times each day. My response is usually the same “I am a trader, I don’t have thoughts on the what the future holds for the market.”

I like saying it because it opens a dialogue which differentiates prediction from trading. The above statement isn’t totally accurate. Of course I have thoughts on the economy, the stock market, trends, unemployment and politics….but these opinions are held distinctly separate from my trading.

Most people have the notion that if they can predict where the stock market (or any asset) will be in a couple months (or any time frame) they can make a boat load of cash. Of course even if reasonably certain about where the market will be there is always some room for doubt…we just never know for sure!

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Yet we try to convince ourselves that we are going to right. We basically “hype” ourselves up to take the trade by telling ourselves “Oh, yeah, it will work out. I am going to make a killing. This is going to be awesome.” We base a trade off our prediction and our hyped up viewpoint.

One problem is that if I succeed in hyping myself up I am no longer considering the possibility that I might be wrong. This means I am more inclined to risk more on the trade than I should. It astounds me that investors will put all their money in one or two stocks. They predict the stock price will do up, and are betting everything they have on it. This is NOT how you should approach the markets, no matter what time frame you are trading on.

Always allow for the possibility that you are wrong. Do that by only risking 2% or less of your account on each trade. That way if you are wrong, it doesn’t hurt too badly. I risk than 1% of my account on each trade.

Even if the market does go up, our prediction is too general to be of use. The market is not like flipping a coin like most people think. It doesn’t only go straight up or straight down immediately after a trade is taken. It can go up a little then drop a lot, then rally a lot, and then drop a little, and then do almost nothing for days on end. We may expect it to move a lot and it doesn’t, or move a little and it moves a lot. Look at the market each day and determine how it is moving to establish some expectations.

If there is very little movement, then believe what the market is telling you. Don’t try to predict when it will breakout or start moving again. The price will tell you when that happens. Trade what the market gives you.

If the trend is dropping and there is a weak pullback, we can expect that the price will keep dropping… but just acting impulsively on that thought is a baseless prediction.

Avoid baseless predictions. Every trade should be a based on a strategy that has been tested and that you have traded in a demo account showing it to be profitable for you.

Assuming a strategy will work for you because the strategy worked for someone else is also a baseless prediction. We are all slightly different and a strategy I use may not work for you, or a strategy you use may not work for me. Test it out. Don’t leave anything to chance.

Final Word on Prediction

You don’t need to know which way the market is going to go to make money. That is why traders seek out strategies — to eliminate the need for prediction. The strategy gives a mathematical edge and tells them exactly how to enter and exit trades.

Step 1: Break the financial matrix

If you think trading is hard, you’re right. It turns out that up to 80–90 percent of non-institutional traders (those who don’t work at financial institutions) lose money when trading . This high percentage has prompted regulators to force brokers to publish data about their clients’ losses on their own platforms. That’s why you’ll find the following language on the websites of countless investment companies: “Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 79% of retail investor accounts lose money when trading spread bets and CFDs with this provider.”

These warnings don’t really solve the problem, and have been about as effective as GDPR cookie compliance (i.e. they have virtually no effect whatsoever). If anything, the broker is just fueling the potential client’s desire to beat the odds: “Are you one of the 21 percent?”

It is increasingly difficult for traders to beat the market due to the rise of “algo trading,” which virtually eliminates any chance for mere mortals to make money trading on a short-term basis.

It is also becoming increasingly difficult for traders to beat the market due to the rise of “algo trading” (the use of computer algorithms), a strategy that virtually eliminates any chance for mere mortals to make money trading on a short-term basis. If you have ever tried trading a company’s earnings the market will have moved before you had a chance to react (as the below graph demonstrates).

Day trading is now the least profitable way to trade, as only advanced supercomputers can now benefit from world news and company earnings. A trading floor no longer has 200+ sweaty middle-aged men throwing their hands up in the air like Hollywood wants you to believe; they have been replaced by machines implementing financial artificial intelligence, commonly known as FinTech.

So why do people still think day trading will make them rich? This can be explained by the fact that day trading is widely advertised as an effective strategy by the mainstream brokerage industry and financial media. Once it is shoved down retail traders’ throats, they cave in to the constant propaganda and lose money quickly by sticking to unprofitable strategies whilst utilizing the “education” offered by the brokers, which is code for “learn how to give me all your money in the fastest way possible.”

Day trading is now the least profitable way to trade, as only advanced supercomputers can now benefit from world news and company earnings.

The entire industry is based on suckering desperate individuals into a false narrative. They say it is easy to make money—all you have to do is trade on charts with no fundamentals and you’ll be sitting on a beach sipping a piña colada in no time. But let’s ask the obvious question here: If trading were that easy, why isn’t everybody doing it?

The truth is it’s almost impossible to make money if you are a retail trader; the small percentage of people who do succeed have had sufficient training and education. Realising you are stepping into a financial matrix where everything being thrown at you forces you to lose money instead of gain, is the first step required to making informed decisions.

Step 2: Learn how the “smart money” consistently predict the market

It’s important to understand that two herds exist in the financial markets: the dumb money and the smart money. “Dumb money” refers to nonprofessional investors, “smart money” to institutional investors who work at investment banks and hedge funds. These professional individuals use the same processes to create trade ideas and views on currencies, commodities, stocks, and bonds. Their strategies only differ from each other in terms of the assets they decide to trade.

Since the smart money are analysing the same data and following the same indicators, a smart money herd mentality is created. The internet allows outsiders to get a glimpse of that mentality—to predict what the smart money are doing and what position they may take on a certain asset.

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