Archives of “Prediction” tag

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True Nature Of Predicting

  
  Education
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Here’s how it works.

If I make an outrageous prediction or label a prediction outrageous and I am wrong, I respond to criticism like this:

“Well, I said it was an outrageous prediction.”

This discounts my responsibility for being wrong to some degree. But if I am right, I will say,

“look how brilliant I am. I made an outrageous prediction and it was dead on.”

Outrageous predictions are used to manage impressions. One defers responsibility if wrong and gloats incessantly if right.

It is a manipulative gambit.

People, who make outrageous predictions know exactly what they are doing. Their potential reward is much bigger than the risk they are taking of being publicly laughed at. Many people have made a career by being right once about a major event that nobody expected (usually a big market correction).

Predicting and speculating have a lot in common, but they are also very different. By definition, predictions are about dealing with factors, you have no control over. When you speculate in the stock market, you also don’t have control over which one of your trades will be profitable and for the most part how profitable it will be. You could improve the odds, but you can’t impact the outcome of each individual trade. When you speculate, you put your own money at risk. You could be right for the wrong reasons and make money (lucky). You could also be wrong despite having an edge and still lose money (no approach has 100% success rate). Since you have very little control on some of the variables that impact your results, it doesn’t really make sense to speculate about only one outcome, because in this case you are getting prepared for only one outcome. The solution – You develop several different scenarios and you prepare for each of them.

A) You could be wrong

  • where is your stop loss?
  • How much of your capital are you going to risk?

B) You could be right (more…)

Links For Traders

  
Education, LINKS
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Interesting reads:

My take on how to read financial news headlines

  
Analysis, Education
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Headline: Stocks Rose/Fell Today by 1% Because of _______
How to read it: Millions of shares traded hands today because investors all have different goals, strategies, risk profiles, holding periods and ideas.

Headline: [Popular economist/fund manager] Expects Market Volatility to Pick Up Later This Year
How to read it: Saying you expect volatility to pick up at some point in the future is like saying you expect it to rain at some point in the future. And volatility works both ways — to the upside and the downside — so really this is just a way of saying the markets will fluctuate, which of course they will.

Headline: George Soros Gained/Lost $1 Billion
How to read it: Soros has around $25 billion so what he does with his money shouldn’t concern most investors.

Headline: Markets Got Slaughtered Today: A Sign of Worse Things to Come?
How to read it: No one ever really knows why stocks rise or fall on a single day. The market is up just over 50% of all trading days and down just under 50% of all trading days so you can never put too much stock in any one day.

Headline: Investors Are Dealing With More Uncertainty
How to read it: The future is always uncertain. The past just feels more certain because now we know what really happened.

Headline: Are Market Overbought Here? 
How to read it: Ask us again in a few months.

Headline: [Democrats/Republicans/current or past president] Caused X% of Economic or Stock Market Growth
How to read it: Presidents or political parties don’t personally control economies or stock markets made up of millions of participants and trillions of dollars all wrapped up within a complex adaptive system. These things don’t come with levers that you can pull to make them rise or fall.

Headline: The Stock Market Enters a Painful Correction
How to read it: Retirement savers rejoice as stocks fall on the week. Those with decades to save & invest should hope it continues.

Headline: _____ Could Cause Gold Could Rise to $1500/oz.
How to read it: Total guess. No one has a clue.

Headline: Is This the Stock-Picker’s Market We’ve Been Waiting For?
How to read it: It’s both always and never a stock-picker’s markets because it all depends on the quality of the stock-picker, not the market.

Headline: Goldman Sachs Expects Stocks to Rally For the Next 3 Months
How to read it: Big financial firms have so many strategists that there will surely be a research piece put out in the coming days that totally contradicts whatever they just predicted.

Headline: When Will the Fed Raise Rates?
How to read it: Has Fed policy really ever helped you make better investment decisions? Even if you knew exactly what they were going to do in the future you still have no idea how other investors will react. 

Headline: Investors Panic as Stocks Enter a Bear Market
How to read it: Don’t panic — expected returns and dividend yields go up during bear markets. This is a good thing for long-term investors.

Headline: A Perfect Storm Caused Markets to Fall
How to read it: Stuff happens in the markets and we like to attach important-sounding narratives to everything. 100-year storms now seem to come around once a month or so. (more…)

Friedman, Fortune Tellers (Book Review )

  
  Education
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I just finished reading Walter A. Friedman’s Fortune Tellers: The Story of America’s First Economic Forecasters (Princeton University Press, 2014), which I highly recommend. Readers will probably be familiar with some of the main characters, but in a depersonalized form—for instance, Babson action/reaction lines and Moody’s Investors Service. Other characters, such as Herbert Hoover and Irving Fisher, are rescued from the one-sided simplifications of history—failed president during the Great Depression, false prophet who claimed just prior to the 1929 crash that the stock market had reached “a permanently high plateau.”

Friedman accomplishes two main tasks in this book. First, he brings his characters to life, recounting their personal, intellectual, and entrepreneurial successes and travails, their pet social and political ideas (more…)

Probability and reward-to Risk Assessment -Traders Must Read

  
  Education
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  • Never open a position without knowing the initial risk.
  • Define your profits and losses as a multiple of your initial risk (R-multiples).
  • Limit your losses to 1R or less.
  • Make sure your profits on the average are bigger than 1R.
  • Never take a trade unless the reward-to-risk ratio of that trade is at least 2:1 and perhaps even 3:1.
  • Your trading system is a distribution of R-multiples.
  • When you understand #6, you should be able to hear/see a description of a system and know the kind of R-multiple distribution it would generate.
  • The mean of that distribution is the expectancy, and it tells you what you’ll make on the average trade. It should be a positive number.
  • The mean, standard deviation, and number of trades determine the SQN score for your system.
  • Your SQN score tells you how easy it will be to meet your objectives using position sizing strategies. Other than that, your system has nothing to do with meeting your objectives.
  • Systems are usually named after their setups, which are usually based on some attempt to predict future prices. Prediction has nothing to do with trading well.
  • System performance has to do with controlling risk and managing the position through your exits.

Predictions vs. Expectations

  
  Education
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There are two VERY DIFFERENT terms to consider when it comes to trading: 1) Prediction and 2) expectation (or confidence) surrounding the prediction. 

Placing a trade involves making a prediction. It is not possible to place a trade without making a prediction, and that is true even for trades that might or might not execute, such as those placed using a stop order or limit order, for example.

Every trader who places a trade does so because the trader believes there is some chance, greater than 0%, that the trade will be beneficial, perhaps based on historical probability (back testing) perhaps based on intuition (years of trading experience) perhaps based on hopes and prayers or possibly based on nothing more than a need to gamble. Whatever the basis, there must be SOME chance to benefit or else the trader would not entertain it. The trader predicts he or she will benefit, or else the trader does not enter a trade order.

No matter what the prediction may be, so long as the EXPECTATIONS for the prediction are based in reality, there is nothing inherently wrong with making a prediction. As long as a trader accepts a 30% win rate, for example, and makes allowances accordingly, there is nothing wrong with taking such a trade. The same is true for trades with 50/50 odds, as long as the trader properly predicts, expects, and is prepared for 50% failures; which is why it is possible to flip a coin and still be successful. 

Many successful traders may say they never predict, when what they may really mean is that they never EXPECT their prediction to come true. Thus they may say things like “I only react” when more accurately they are reacting… to a failed prediction. For, it is virtually impossible to trade without predicting. So, I say to all you new traders out there “Don’t be afraid to predict. Just know how likely it is that you’ll be wrong, and know what to do when your prediction fails!”

These 7 Things -Traders Must Avoid

  
  Education
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  • Trading with no stop losses. You can’t control how big your profits are, the market will trend as far as it does. However, you can control and limit the size of your losses with a stop loss and a carefully managed positions size. Not having an exit plan if you are wrong can be very expensive when a trend takes off against your position and you start hoping instead of just cutting your losses and moving on.
  • Your opinion can cost you money. Trading your opinion against all other market participants can be very expensive. The market goes where it wants and when you disagree with where it is going it will cost you. Going with the flow in your time frame is the best way to make money. Fighting the flow of the market can be expensive.
  • Egos are expensive things. Inflated egos cause a trader’s #1 priority to be proving they are right and refusing to admit when they are wrong. It is very expensive for ego gratification to be higher on a trader’s list than making money.
  • Trading off predictions can cost a lot of money when they are wrong. There is more to be made by reacting to what the market is doing instead of predicting what you think it will do later. The future does not exist and it is expensive to pretend like it does.
  • Stubbornness causes small losses to become big losses. It causes a trader to make the same mistake over and over because they do not assimilate feedback. Instead they keep doing the same thing over and over and expect different results but keep getting the same results. Stubbornness is expensive.
  • Not having an exit strategy for a winning trade can be very expensive. It is possible to ride a big winning trade back to even. If there is no plan to lock in profits while they are there a winning trade can even turn into a big loser. Trailing stops and targets can put the profits in the bank.
  • Trading too big of position sizes for your account can be very costly because no manner how good your winning trades are you are set up to give back the profits with a few big losing trades in a row,
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