Why We Stink at Forecasting

In a very interesting post on our inability to forecast, Barry Ritholtz writes:

Even though predictions are almost useless, we persist in making and listening to them …

Click on the link below to read further:

10 Points About Forecasting and Why We Stink at It

While you are at it, you may also want to read the chapter “On Forecasting” in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”

#RidingTheRollerCoaster

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राम नवमी की शुभेच्छा

जब कभी भी कोई पूछता है की, “मार्केट ऊपर जाएगा या नीचे?” या फिर “मार्केट कहाँ तक जाएगा?” तोह हंसी आ जाती है. पता नहीं लोगों को क्यों लगता है की किसीको भविष्य के बारे में पता होगा.

आज राम नवमी के दिन यह याद कर लीजिये की भगवन राम को पता नहीं था की अगले दिन अपने राज्याभिषेक के बदले वनवास होगा.

जय श्री राम.

Do you know the future?

It amazes me how frequently the same questions keep coming back.

Some of the most common questions are:

  • “Which mutual fund schemes are the best according to you?”
  • “Which is the best mutual fund? Or best stock? Or best investment?”
  • “What is your view on the market?”
  • “Should I invest now or wait for some time?”
  • “I have invested in ********* mutual fund scheme(s). How much returns should I expect?”
  • “I have invested in ********* mutual fund scheme(s). Are these good schemes or do I need to make any changes?”

All the above questions have one thing in common – an attempt to know the future. It seems the entire business of investment management may be about predicting the future. And the investment expert is a professional forecaster.

The fact is, most have failed to correctly predict the future events – even the best of the investors. Let us see some examples and we need not go too far in the past. In the last seven months of the year 2016, the world witnessed three major events taking place in three different parts of the world.

First in the month of June, the people of Britain voted for exiting the Eurozone during the referendum, whereas majority had predicted that Britain would remain in the Eurozone.

On November 8, while many experts were expecting the US to get the first ever lady President, the result was very different.

In both the above cases, while there were only two possibilities, the actual result was exactly opposite of the popular opinion.

On the other side of the world, on the same day, November 8th, the currency notes of Rs. 500 and Rs. 1,000 were pulled out of circulation. I am sure nobody had any idea about this. No forecaster could predict such an event happening.

Continue further on the US election results, majority of the market experts and economists had expected that a Trump victory would spell disaster for the US. What happened in reality? Post the announcement of election results; the US Dollar has gained against almost all major currencies of the world. Can someone say that the fall of the Dollar was already factored in the price and hence post the victory of Donald Trump, the Dollar only recovered? Well, even that argument does not hold water, since majority was of the view that Hillary Clinton would win the election. There was no question of the unexpected being factored in the price. So, it was not a case of a political forecast gone wrong, but also a market forecast going wrong.

Sir John Templeton has famously said, “Buy value, not market trends or the economic outlook.”

The subject of investment management for most retail individual investors is to ensure enough money is available at the time of one’s life’s financial goals. In such a scenario, one must manage the investment risks such that the money becomes available at the time of need.

For that purpose, the important thing is to understand what can go wrong and how to protect one’s investments. Forecasting the future is not required.

  • Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

#RidingTheRollerCoaster

Donald Trump in White House

Majority of people believed that Hillary Clinton would get elected as US President. Most opinion polls predicted the same. But, finally when the results were out, everyone was taken by a surprise.

For the political (and other) forecasters, this was just another day at office – another instance of a forecast gone wrong.

 

Read the chapter on “Expertise and Forecasting” in “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”. The book is available in English (hard bound), Gujarati (hard bound) and e-book formats.

#RidingTheRollerCoaster – 263

What should you believe?

Have a look at these two posts:

  1. A post I wrote some time back: Experts cannot predict, and
  2. An interview of Udayan Mukherjee

I would leave it for you to conclude, whichever way you want.

The profession of forecasting has a great future.

#RidingTheRollerCoaster – 236

 

Forecast gone wrong – once again!

Today P V Subramanyam posted on Facebook a comment on something he had posted last year.

Here are the two posts:

On 7th September 2015:

Shankar Sharma has called this a bear market..this means market has to drop 25% from here. So the sensex target should be 19000. Take care. 

PS: I am learning to write humor…

On 7th September 2016:

posted this a year back..no clue where is Shankar Sharma…but the sensex is not at 19000 for sure….

Just for records, Sensex closed at 28,978.02 points yesterday. It was at 24,893.81 points on 7th September 2015. So in the last year, it has risen by 16.41%. Does not look like a bear 😉

This is another case of a forecast going wrong. Why do the forecasters keep trying? Why do people keep listening and believing in these forecasts?

Well, there is a human tendency. There is an urge to know the future before it happens. However, it isn’t going to happen to anyone. Here is an excerpt from my book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”:

There are many small stories in the epic Mahabharata. In one such story, a beggar comes to the Pandavas asking for some help. They are in the midst of a discussion, and Yudhisthir, the elder brother, asks the person to come the next day. Hearing this, his younger sibling, Bheema reminds Yudhisthir of the audacity of assuming that he would be alive tomorrow. This story highlights the importance of understanding uncertainty associated with the future.

Humans have always wanted to know the future. Astrologers and weather forecasters are among the most popular ones who make a living from this need. Someone who can see the future is called a “visionary”. This need to know the future is present in the world of business and finance, too. There are large numbers of analysts and forecasters, who make a living – in fact, many make a killing. However, the track record of such forecasts is not as impressive as one would like.

#RidingTheRollerCoaster – 235

Extrapolation …

One of the most common approaches to estimate future is extrapolation of the past. We have been taught to identify trends and extrapolate these into the future – sometimes into the infinite future. However, many things in life, especially the financial market returns, are cyclical and they do not move on the same trendily forever.

This is where the fallacy of forecasting lies. Very often, we are able to correctly forecast so long as the trend continues. However, identifying the trend reversal ahead of time is almost an impossibility. That makes our prediction track record unreliable. We are right some time, and wrong at other times.

Be careful of forecast based on extrapolations.

#RidingTheRollerCoaster – 229