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Please Don't Fall for This Common Investor Trap

January 23, 2013 | About:

Those who make their living from crystal balls must dine on broken glass.

It's an interesting insight. It's just not true.

Most Wall Street suits see no consequence to their bad calls. They keep appearing on CNBC, and collecting paychecks from the firms that employ them. If any broken glass is eaten, it's served to the ordinary investors.

How nice it would be, then, to ignore the crystal ball biz and shun all predictions entirely. But there's a problem: Investing for the long term means taking on risks. That means you have to get a handle on the dangers and opportunities tomorrow could bring.

Some predictions are "good" in this regard. They are useful or thought provoking. The vast majority are bad.

So as you navigate the fever swamps of muddled market thinking, you need to understand two things:

  1. What the hallmarks are of the "good" -- i.e. useful -- prediction (relatively rare).

  2. What the hallmarks are of a "bad" -- i.e. useless or downright dangerous -- prediction.
Consider the following a rough guide:

Demand Driven Versus Insight Driven

Most pundits predict on a schedule. It's their job to tell you what they see for the coming month, quarter, year and so on.

It is almost always a waste of time.

This is demand driven. Investors want to know "what will happen by X date." But working off a calendar produces little value.

"Good" predictions, by contrast, are insight driven. This makes them highly resistant to set schedules.

Insight does not show up on a timetable, like a Swiss commuter train. Instead, it pops in out of the blue, like your crazy relative from the coast.

You can cultivate insight. But you can't know when it will come. When it does there is often money to be made. That is why smart investors always keep a reserve of "dry powder" (cash on hand).

Little Picture Versus Big Picture

Bad predictions are typically obsessed with the "little picture" -- where the Dow will be next week... or whether the next jobs report will surprise to the upside.

This is "noise" -- useless in other words. The closer you get to the realm of random fluctuation the less your predictions matter.

Good predictions tend to be "big picture" oriented. They focus on the grand sweep of history: game-changing events, seismic economic shifts and paradigm-changing trends. Like deep ocean currents, they are not preoccupied with swirls on the surface.

Anti-Historical Versus Historical

Bad predictions are blind to history. There are countless variations of "this time it's different" or "here's why XYZ will never end."

The anti-historical poster child of late is Apple Inc. (NASDAQ:AAPL).

As Apple shares soared to $700 a share, history-blind bulls argued that the profit tree... and the share price... would keep growing to the sky.

Then growth projections took a whack. And Apple shares fell 30% in a matter of months.

Bad predictions often run afoul of market history. Good predictions are historically aware and historically informed. They go a step beyond plausible... and into the realm of the probable... by drawing on time-tested lessons from human nature.

Arrogant Versus Humble

People who make bad predictions tend to do so with supreme confidence. People who offer the rare good prediction tend to be more humble.

Think of the line from Yeats: "The best lack all conviction, while the worst / are full of passionate intensity."

Wise investors know the world is a complex place, with many moving parts, and are hesitant to "pound the table" -- even when they think they are right.

More important, the wise are fully aware that no one can know everything. And knowing what you don't know is one of the most important attributes of a successful investor. It helps you avoid a "ruinous loss" by betting big on a bad idea and failing to consider the downside.

Carpe Divitiae,


Rating: 4.1/5 (7 votes)


Praveen Chawla
Praveen Chawla premium member - 4 years ago
Great read. These talking heads and media like CNBC are essential to wall street. They bring in the sheep for the shearing and sometimes the slaughter.

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