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Why stock tips are dangerous
Dhirendra Kumar
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August 21, 2006

Last week, on a television show on Doordarshan in which I was appearing, a viewer called in and asked why stock analysts were wrong seven times out of 10. He also asked what would happen to the market in the coming week, which made it clear why his first question was irrelevant.

Now, we all know it's not possible to predict what is going to happen in the market in the short-term. Yet, all kinds of media, especially the business television channels, work hard to maintain the illusion that this is not only possible, but routine.

To explain how this illusion is maintained, let me tell you an old Wall Street joke about how someone built up a reputation of being a great analyst.

A broker sent a letter to 1,000 people, telling half of them a certain stock would rise in the coming week. He told the other half it would fall.

The following week, he wrote another letter, but only to the 500 to whom he had chanced to send the correct prediction the previous week. Again, he told half of them (ie 250 of them) that the stock would rise and the other half that it would fall. After repeating this exercise for six weeks, he had a residual audience of about thirty people with whom he had built up an impeccable reputation of correctly predicting a stock's movements for six weeks running. Then, I assume, he proceeded to milk these people in some way.

While this is (I hope) just a joke, a variation on this theme has become the bread and butter of modern business media. A lot of experts say a lot of things. Mostly, they earnestly try and make intelligent predictions. Most of the time, a majority of them are wrong but some are correct. Sometimes, when the markets are in a less than normal phase of unpredictability, a larger proportion is correct.

All this activity keeps much of the audience under the vague impression that it is possible to predict things correctly because, after all, someone or the other is always right on at least some of the things, some of the time. Then, investors take this belief in the short-term predictability of the market and try and get advice on their own investment.

The individual investor who gets burned always concludes he did not get the right advice. He never stumbles upon the correct explanation, which is that if you want short-term predictions that are guaranteed to be correct, then such a thing as the 'right advice' does not exist.

For your short-term investments, you can get advice that has a 100% chance of being correct 1% of the time or advice that has a 1%chance of being correct 100%of the time. You can even get advice that has 1% chance of being correct 1% of the time, but that's about it.

It's a little like what Abraham Lincoln once said, 'You can fool some of the people all of the time, and all of the people some of the time, but you can not fool all of the people all of the time.'

So please, dear reader, stop looking for tips. Get serious about your investments and invest believing in the business and company. 

The author is the CEO of Value Research, a mutual fund research organisation.

Value Research

 


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