Did I catch you on that ? are you expecting someone would be able to predict that for everyone ?

For the last one year, there has been an army of people trying to predict the end of the bear market. Most of the so called pundits were expecting the global recession to end by Q1’09. Now the predicitions have shifted to Q3’09 or towards the end of the year. The same pundits were predicting oil to touch 200 dollars a barrel. As the saying goes – If I had a penny everytime a bozo made a prediction, I would be rich !

I would suggest you to read N N taleb’s books – Fooled by randomness and The black swan which talks of this bias. All of us have this strong desire to predict and see patterns. It is a strong, innate human tendency which causes most of us to seek predicitions of the future and see patterns where none exist. The problem with markets is that there are often no such patterns and the future can rarely be predicted accurately for a long period of time. Yes, some so called gurus can get one predicition correct, but that does not mean that this person has some special ability to see the future.

If you predict often, you will be correct a few times too. There is considerable research into the accuracy and success rate of such predictions and most of the studies point to less than a 50% success rate. That is worse than a coin toss !!

How to invest without predicting the market ?
So how does one invest, if one cannot predict where the market will be in the future ? I think there is a big mis-understanding that one has to know where the market is going, to be a successful investor.

If you plan to invest in an option which will expire at a fixed time, then you will need to predict how the market will perform during the duration of the option. However if you are able to identify a good company with a sustainable competitive advantage, which is likely to do well over the next few years, then you are likely to get a good return on investment.

As the company does well, the underlying intrinsic value is bound to increase. When this happens, the gap between the price and the value will increase (assuming the price is stagnant ) and the stock will be get progressively more undervalued. In most of the cases (not necessarily all), this undervaluation will create an upward pressure on the stock price. In most of these cases, the gap closes suddenly and the returns are made quickly over a very short interval of time. It is however diffcult to predict when this will happen.

So what happens if the price takes longer to recover ? Well, if the intrsinc value is increasing, then you have an opportunity to increase your holding as the gap keeps getting larger and the returns should be better when the gap finally closes.

So why does’nt everyone do it ?
For one, it is painful to watch your stock stagnate over long periods of time. If you look at price to validate your decision, then a stagnant price only increases your self doubt and anxiety. Most investors are not wired to ignore the price and focus on the intrinsic value. That also explains why it is diffcult to practise value investing.

Where do we go from here ?
For starters, stop trying to figure when the bear market will turn. If your imvestments are based on the market turning soon, you could be in for a lot of dissapointment if that does not happen.

I personally watch CNBC, read the news and listen to all possible predicitions from all and sundry, but only for entertainment. Whenever some tries to give me an elaborate reason on when the market will turn or the recession will end, I have a single thought in mind – ‘How the hell do you know ?

What am I doing ?
I am reviewing my current holdings. The Q3 results have been announced for most of my holdings and I am in the process of analysing the same.

In addition I am focussing on learning about behavioral finance and biases. I would be updating my templates based on my learnings and would be re-analysing my holdings again. It is quite possible I may discover that I should exit some holding and some bias is holding me back. I will be posting such analysis when I come to such a conclusion.

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