Profit Without Predicting the Market

Investors, especially short-term traders, are usually better off waiting for a price movement to confirm a trend or reversal rather than trying to predict what will happen next. Here’s a look at the reasons why predicting prices is problematic, then some ways you can rework your thinking to gain a better edge.

Key Takeaways

• No one can predict what the market will do because there are too many variables.
• Short-term traders are typically better served by waiting for confirmation of a reversal rather than making an assumption or predicting it.
• Viewing price action as a series of waves is an alternative to predicting future price moves.
• You should establish significant points to buy and sell based on what a price is actually doing rather than what you expect it to do.

Problems with Predicting the Market

Why is predicting problematic? There are a variety of reasons—here are a few.

Change Is Certain

No matter how good an analysis is, it is only as good as the information that is available right now. You cannot know for certain what will happen tomorrow or even an hour from now. Analysis regarding likely movement in the future is done with the idea of “ceteris paribus” or “all else being equal.” This means an analyst assumes a stock will go up based on a trend if everything else but one or two variables remain constant. In the short term (minutes, hours, days, maybe weeks), macro-level changes like Federal Reserve interest rates can remain the same. However, micro-level changes, like investor choices, cannot be anticipated.

For example, predicting that an asset’s price will rise when others are falling is risky, especially since it can’t be known how the market will react to further news or information that is released. 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 adverse effect on prices.

Individual Stocks Don’t Always Follow the Overall Market

Individual security analysis is often based on the sentiment of the overall market. This can mean a trader expects one stock to rise because benchmarks indicate that the market is rising or that it will fall because the market has declined.

Stocks do not always mimic the market, especially in shorter time frames. Traders must be aware of market dynamics as well as individual stock dynamics. Either way, the end result is that you want to be trading in the direction of current cash flows, not against them, whether it be in the overall market or individual securities.

Predictions Are Vague

Predicting that a particular stock will move higher is vague because most predictions are based on historical trends and assumptions that, again, all else will remain the same.

Investment decisions then rarely include a profit or stop-loss exit point due to the expectation of a continued trend. Inexperienced traders often predict that their equity positions will rise and assume that they will be able to exit near the top if they are correct. In reality, such a vague plan rarely works. Therefore, all traders must have a plan for entering and exiting a trade based on how much they are willing to lose and gain.

Market Volatility Has Increased

Stock market volatility has increased over the years, while the holding period for securities has fallen. 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.

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 you 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 than looking for one trade or stock that rises aggressively in their favor in a short period.

Important

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

Alternatives to Prediction

Given an understanding that trying to predict a turning point in the market can be very costly, one might ask, “If I can’t predict the market, how do I make money in it?”

The answer is to follow the price, which you can do using a couple of mantras. They are hardly an exhaustive list of market dynamics, but they are key: “Prices fluctuate in waves” and “Don’t assume support or resistance will hold.”

Prices Fluctuate in Waves

Looking at any chart after understanding the points above, all traders must understand that prices move in waves in 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. Predicting that prices will move in only one direction disregards the fact that prices tend to move in waves.

Don’t Assume Support or Resistance Will Hold

A widespread misconception is that support or resistance will hold, or that a break of these levels will cause a substantial breakout. The position traders have is often the result of what they predict will occur. Traders need to realize that support and resistance levels are 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.

Instead, 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 the direction of the breakout. Keep in mind that 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, you’re not predicting that something will occur or go against the prevailing price movement. Instead, you enter into the current price flow. This makes trading “matter of fact” as opposed to emotional. You have picked out important levels that will help you isolate the price waves a market is moving in. Then, you can take a corresponding position as prices react at these levels.

Is it Possible to Predict the Market?

It is very difficult to predict what the market will do, but as the saying goes, every dog has its day. Some predictions will be accurate, but for the most part, they are not—there are too many variables, and change occurs too often.

Can You Mathematically Predict the Stock Market?

You can use probability theory, statistics, and historical data to attempt to predict what the market will do and conclude that it might do something, but this is more of a gauge of risk.

How to Predict the Market Movement?

There is no way to accurately predict how the market will move, but there are methods that can help you mitigate the trading risks, such as setting limits for your positions and your trading amounts and trading the ebb and flow of prices.

The Bottom Line

Traders benefit by remaining nimble in their positions and not being tied to a particular direction because of a prediction. Predicting the markets can be dangerous, and ultimately, predictions are not needed to make money in trading.

By realizing that prices move in waves and that you should never assume that important levels will hold or break, you can enter and exit trades at significant points—but in reaction to what the price is actually doing and not what you expect it to do. Understanding that should help traders find themselves more on the right side of the trade than on the wrong side.