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Explaining the Past and Predicting the Future

The explanation industry that runs with the financial media can't help you with anything, but something else can

What a fascinating study in human behaviour is provided by the short-term swings in the equity markets. The past month, and specially the last week, have provided great examples of how relatively mild movements of the markets can cause widespread fear, uncertainty and doubt. Perhaps the stress levels of investors are already very high and they are primed to get startled and run away at every hiccup.

And that's just the human traders. Nowadays, there can never be any quick sharp move in the market without 'algorithms' getting part of the credit or blame. On Wednesday and Thursday last week, there was plenty of this 'the computer did it' news stories in the financial media. People writing (and reading) these articles seem to have accepted the premise that when something extreme happens, then the algorithms run amok and make the movement even more extreme.

Still, these alien invasion type of explanations are just another stage in a long tradition of the explanation industry that exists around stock market movements. Every day, stock markets do something and someone needs to sit in front of a keyboard or a camera and explain why it happened. Market internals, as well as wars, oil, taxes, interest rates, other economic data, and a lot else can be combined in endlessly entertaining combinations that can explain everything including complete reversals on successive days.

I do not know to what extent these stories are useful for those who are trading on the equity markets over short periods of time. However, they are definitely dangerous for the simple long-term investor if he pays any attention to them.

The basic logic of these explanations is that if one understands them, then one can predict the future path of stock prices. In reality, the only thing one predict (roughly) is one's own financial future. It's much better for an investor to tune his or her investments around the predicted financial events of one's own life, instead of those of economies and industries around the world.