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Why stock market experts tell you nothing

September 11, 2007 09:03 IST

Market strategists, financial analysts and investment experts always say something insightful about the stock markets and the way they expect the stock market to move. They typically have an explanation for every rally and every sell-off.

At times the explanation and analysis for an event, start happening as soon as the information comes in. Makes one wonder, don't they need time to think?

John Allen Paulos in his book, A Mathematician Plays the Stock Market, has a very interesting explanation for this. He writes "Because so much information is available - business pages, companies' annual reports, earnings expectations, alleged scandals, online sites, and commentary -- something insightful sounding can always be said."

But not everything is right about such predictions and analysis. As Jason Zweig writes in Your Money and Your Brain, "All these predictions fall prey to the same two problems: First, they assume that whatever has been happening is the only thing that could have happened. Second, they rely too heavily on the short--term past to forecast the long-term future."

Given their reliance on the short-term movements for long-term forecasts, most of these forecasts turn out to be wrong. As Zweig writes, "Every December, BusinessWeek surveys Wall Street's leading strategies, asking where stocks are headed in the year to come. Over the past decade, the consensus of these 'expert' forecasts has been off by an average of 16%."

Partly the business media is also to be blamed. In its zeal to get to the viewer before anyone else does, the business media ends up oversimplifying things.

As Nassim Nicholas Talib points out in his book. Fooled By Randomness, "The market movements in the eighteen months after September 11,2001, were far smaller than the ones that we faced in the eighteen months prior -- but somehow in the mind of investors they were very volatile. The discussions in the media of the 'terrorist threats' magnified the effect of these market moves in the people's heads. This is one of the many reasons that journalism may be the greatest plague we face today -- as the world becomes more and more complicated and our minds are trained for more and more simplification."

The question that crops up here is why do investors believe everything that such experts have to say. An investor who buys and sells stocks, day in and day out, feels good if he has a feel of where the prices of stocks he has invested in or plans to invest in are headed to.

This category of investors believes in timing the market and timing the market is only possible if they keep track of the innumerable predictions and rumours that keep appearing almost daily in various sections of the business media.

"Just a couple of accurate predictions on CNBC can make an analyst seem like a genius, because viewers have no practical way to sample the analyst's entire ( and probably mediocre) forecasting record. In the absence of a full sample, a small streak of random luck looks like to us a part of a longer pattern of reliable foresight," writes Zweig.

Having said that these are the investors, who want to keep trading all the time and these are the investors who keep losing money in the stock market.

As writes Edwin Lefevre writes in his book, Reminiscences of a Stock Operator, "There is the plain fool, who does all the wrong things everywhere, but there is a Wall Street fool, who thinks that he must trade all the time. No man can always have adequate reasons for buying or selling stocks daily -- or sufficient knowledge to make his play an intelligent play."

By keeping track of everything that the stock market experts say, these investors feel that they have all the information that was ever needed to trade.

US Economists Jeffrey Busse and T. Clifton Green, carried out a research on how the US stock markets reacted to information that was provided in the Morning Call and the Midday Call segments on the business news channel CNBC.

In these segments, recommendations on individual stocks are made. When the recommendation on a stock was positive, the price of the stock went up within 15 seconds of the report being aired.

The point being made here is that the investors just reacted to the recommendation without really waiting to hear, why the recommendation was being made.

As James Surowiecki points out in his book, The Wisdom of Crowds, "All the investors -- or speculators -- cared about was that because CNBC said it, somebody would be trading on it. Once you know that other people are going to react to the news, the only question becomes who can move fast enough."

As Paulos so aptly puts it, "Data, data everywhere, but not a thought to think."

Chandnee Sinha