Can a casual investor effectively predict the direction of the stock market?

Question

Is the stock market an efficient market, with assets whose direction of change in prices cannot be predicted by casual investors?

The reason I'm asking this is because certain family members are pushing me to "get into" the stock market. They claim that I'm a very logical and quantitatively adept thinker, so I could do well. I have a full time job that's nowhere near the finance industry, and I'm nearly illiterate when it comes to finance. I'm very skeptical of the claim that my quantitative capacity will be of any use to me in investing in the stock market, unless I devote an inordinate amount of time.

Great question, new user! One point. You mention quantitative and logical. Those are fine qualities (say for an engineer, or doctor), but utterly no help in trading. Might as well be "My friends suggest basketball, since I'm really short!" Arguably, pretty much EVERY famous ultra-hyper-flop in trading came from "logical, quantitative" approaches. So your comment "I'm very skeptical ..." is correct. Watch some pit traders to see the sort of qualities involved in real-world trading. — Fattie, Sep 14 '18 at 17:44
Relevant: https://en.wikipedia.org/wiki/Random_walk_hypothesis — Jamie Clinton, Sep 14 '18 at 19:23
Can you give an understanding of your current exposure to the stock market? When certain family members say you should "get into it" does that mean you're starting from zero or does that mean they want you to more actively trade your portfolio? There's a big difference between getting into the market and getting into market-timing. — Beanluc, Sep 14 '18 at 20:47
According to this article and the scientific theories it refers to, the stock market is just the opposite of logical and quantifiable. — dlatikay, Sep 15 '18 at 20:42
An "efficient market" does NOT mean that casual investors cannot predict changes in prices. It just means that current prices reflect all available public information. (Markets are not efficient anyway, since prices change every minute/hour/day even without any news.) — 7529, Nov 03 '21 at 15:12

score 53 · Answer 1 · answered Sep 13 '18 at 19:23

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Is the stock market an efficient market, with assets whose direction of change in prices cannot be predicted by casual investors?

Predicting the direction of the market, and prices, is easy. I'll do it right now: "The market will go up." Looking at the S&P 500, for 26 of the last 31 years, I would've been correct. This is, in fact, the idea behind index funds: the market will on average go up, so if you invest in the market as a whole (rather than in individual companies), your investment will go up as well.

Most small time investors (and, factoring in expenses, most clients of hedge funds) who actively trade individual stocks will underperform the market over long periods of time; it turns out that active trading is hard and requires a lot of time, skill, and effort to do better than average. But doing average is just fine, and requires almost no effort.

answered Sep 13 '18 at 19:23

Magua

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Thanks. So why do casual investors, who don't spent a ton of time doing financial research, trade in individual stocks? Are they misguided? Do they know that it's worse on average, but still enjoy the higher volatility (like casino players who know the expected value is against them but still enjoy the thrill of gambling)? Do many of them have friends who do have above-average insights in the market? Or is there some incentive to doing this that I have overlooked? – Bridgeburners Sep 13 '18 at 19:31
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Because it's exciting and gives them a sense of control over their financial destiny. They will also learn whether they are able to "beat" the market in the long run (hint: 90% of them won't). I say this as a full-time daytrader. – misantroop Sep 13 '18 at 20:11
@Bridgeburners arguably, it's a mix of greed and overconfidence... for some people, it's a hobby. – 0xFEE1DEAD Sep 13 '18 at 20:30
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@misantroop I'm not sure you fit in with the "casual investors" – 0xFEE1DEAD Sep 13 '18 at 20:38
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@misantroop: And unlike gamblers (who have roughly the same motivations as day traders), they typically don't lose money in obvious ways as long as they're not riding the penny stock train. They'll see their success in the average case (the up years) as validating their own skill, not noticing that after expenses they're typically underperforming low cost index funds; in the down years, they're not bothered because everyone lost money (and they don't notice they lost more, most of the time). – ShadowRanger Sep 14 '18 at 02:04
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"Why do casual investors...trade in individual stocks?" Complicated question, but I think it boils down to "feeling like they're involved" and/or "feeling like they have special knowledge." Also, if the market on average goes up, and you remember the hits and forget the misses, it's easy to say "I'm making money, look at my good trades," because even underperforming the market can have positive returns. – Magua Sep 14 '18 at 06:12
@Bridgeburners Well, (we) small and part-time investors don't usually day-trade. We (if we want to be successful) are not necessarily looking to make a bargain purchase or sale. We are interested in owning a share in what we perceive as a well run company. Even if you only get a "fair" value for money when buying and a "fair" money for value when selling - we are after what happens between those two moments. When I buy, I buy in companies that I think are 1.) well run and 2.) Well positioned regarding current trends, and future opportunities ("megatrends"). – Stian Sep 14 '18 at 07:39
"So why do casual investors" - because you can make a LOT of money. Point though, if you are one of the lucky (with talent for trhat) you will not satay a "casual investor" for long. The moment your portfolio starts swinging 100k USD on an average day - what good is your "casual" then, and why do you bother with your normal day job? 95% loose money, 5% - well, they make this as main income VERY fast. – TomTom Sep 14 '18 at 08:48
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@Bridgeburners another "why?" is covered in an old answer of mine. The shareholder perks from carefully-chosen companies can massively exceed the dividends: https://money.stackexchange.com/a/55555/22842 At one point if you were planning a trip to Disneyland Paris, you could save more than the purchase price of the shares in a 3-day trip by using shareholder offers. That's an extreme case – Chris H Sep 14 '18 at 10:31
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@0xFEE1DEAD I was once a casual investor. Change to professional happens gradually. – misantroop Sep 14 '18 at 10:58
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Related anecdote: The majority of my net worth is in the S&P 500 index or a close equivalent. Over the years, I've also dabbled in individual stocks. I just can't help myself. I've hit some home runs, too. But overall, my individual stock picks have trailed the market by 2%. I'd have been better off entirely in index funds. – Rocky Sep 14 '18 at 16:26

score 6 · Answer 2 · answered Sep 13 '18 at 23:25

Sounds like your real question is "people are telling me to get into stocks, but I don't want to, should I do it?" - obviously the answer is no. You should not risk your money on something you have no interest in.

However, I also get the impression that you're not disinterested in finance, you are just very unfamiliar with it and think you will be disinterested. There's not much risk in just doing some reading and trying to learn a few basics to see if you are interested. And in saying:

They claim that I'm a very logical and quantitatively adept thinker.

Your family members make a good case that you might find it interesting. Just because you're logical and good with numbers doesn't mean that you will succeed in finance, of course (there have been plenty of math geniuses that ended up doing very poorly), but it helps!

I'm very skeptical of the claim that my quantitative capacity will be of any use to me in investing in the stock market, unless I devote an inordinate amount of time.

Your actual specialized skills probably won't transfer at all. However, being familiar with basic math concepts, as well as with tools used to crunch numbers and analyze data, makes it a lot easier to learn.

Time-wise, there are definitely people who invest effectively despite having a job. It all depends on your goals and specific strategy. Setting up an automated order to buy $1000 worth of index fund shares every month requires barely any time (or skill, beyond the skill of leaving it alone) and is actually an effective strategy - if you can actually stick to it through an inevitable market crash and subsequent recovery.

As for the more general questions:

Can a casual investor effectively predict the direction of the stock market?

Good thing you said "effectively" because no we can easily answer "no". The index usually goes up, so people usually predict that it will keep going up, so it seems like they can predict it. However, every so often it starts going down rapidly, at which point the casuals are likely to panic and sell at the bottom, which results in a big loss.

In other words, even if you just always predict the market will go up, and invest based on that, you will most likely get a good return. However, "always predicting up" is hard to do: During a crash, many people find themselves thinking "maybe this time it won't go up after all" which can make all the difference.

Is the stock market an efficient market, with assets whose direction of change in prices cannot be predicted by casual investors?

The market is pretty efficient, but it is also very irrational. Overall it will tend to favor companies with solid fundamentals and successful businesses. But on any given day you can find many apparently great companies with terrible stock performance, and vice versa. Whether you are wrong about them being great, or the investors, and when (if) the investors will change their mind, are big questions that will impact any decision to invest.

score 3 · Answer 3 · edited Sep 14 '18 at 13:27

The price of stocks usually reflects the knowledge of the market, the value of the company and hope for the future prospects of this economy.

On average, even professional traders fail to beat index funds who aren't trading.

There are trading bots that try to buy/sell all the time before the knowledge reaches the market while scanning new portals - and you need to act like that to get an advantage over the market knowledge - even when you fall for Tesla price manipulation.

Personally, I think patience and diversification is more important when investing in the stock market if you keep this in mind and invest money you don't need now then you will usually beat loans from papers and your bank. The big indexes always had a very good process over a 7 year rhythm despite big crises.

Normal people who invest often make the mistake of investing when the market is doing well and selling during the crisis instead of waiting for better times. Sometimes it is good to invest that money and forget about it. They may invest in a sector they believe in and if that sector performs well, they'll make a lot of money. Like the dotcom crisis, there is a high risk of failure if this sector develops big problems.

Edit: I forget the "risk" as a major factor for price. Simply said, if you buy blue chip companies, you'll gain a steady income with low risk but usually, you won't make quick money. The higher the risk, the higher the income opportunities should be and the more important diversification becomes.

+1 for "patience and diversification". Also, good point on risk vs reward. — 0xFEE1DEAD, Sep 13 '18 at 20:34

score 2 · Answer 4 · answered Sep 14 '18 at 10:03

According to this report, only 18% of large-cap managers, 13% mid-cap managers and 6% small-cap managers managed to beat the market over a 5 year period, and these figures fall to about 6-7% for all managers over 15 year period. These are the pros who get paid to do this. Keeping this in mind, even if you actually devoted a lot of time, you'd almost certainly underperform the market on the long run.

score 1 · Answer 5 · edited Sep 13 '18 at 22:54

The stock market always has a level of risk. The more you're willing to risk, the more you could potentially gain, and the more you could potentially lose.

The more knowledge you have about the stocks in which you invest, the more informed decisions you can make about what and when to buy or sell, but nothing in life is guaranteed.

You can't predict if the CEO is going to steal all your money and go into hiding forever. But you can calculate the likelihood of that happening based on history.

Knowledge is power but nothing in life is guaranteed.

There are websites (my bank for example) where you can invest "pretend money" on real stocks to practice trading and get used to the process. There's no risk, but you if you do well, you might become a pretend millionaire.

score 1 · Answer 6 · answered Sep 14 '18 at 17:53

The key point here is "... unless I devote an inordinate amount of time". Trying to do individual stock trading successfully really is a full-time job. If it's not something you enjoy for its own sake, there are better ways to spend your time.

Beyond that, predicting "the market" is a lot different than predicting individual stocks. Sure, the prediction that "in the long run, stocks will go up" is true*, but that's not much consolation if one of the individual stocks you invested a good chunk of money in was Enron.

*At least it has been true, historically, but as they say in the prospectus, "Past performance is no guarantee of future results".

score 0 · Answer 7 · answered Sep 14 '18 at 16:22

We'll cut out all the fluff here:

You can't predict what you'll have for breakfast tomorrow with 100% certainty, you certainly can't predict the market
The market is not efficient, or rather the efficiency of the market depends on the resolution with which you look at it. At a high, low resolution level, it is mostly efficient.
There are efficient strategies for investing, only some of which will be practical for you to use
Your level of interest/time determines which strategies are practical for you
Being analytical and quantitatively adept, as you say, increases the number of efficient strategies available to you.
The number of efficient strategies available to you grows on a logarithmic curve relative to your time investment - a little time investment gives you many strategies, as you add more time, you add fewer strategies.
As you add more time, provided you have the skills/talents to utilize that time effectively, the strategies that require that time increase in leverage - e.g. the value of a strategy, executed properly, grows on an exponential curve relative to time.

If you want to see how this plays out on the scale of billions of dollars, read The Big Short. You'll see the parallels. There are many people, you may be one, I may be one, who could employ those time intensive strategies to find small opportunities with comparatively astronomical leverage and minimal risk. It takes a lot of learning and preparation to be able to do that successfully.

On the other hand, I employ a pretty basic strategy that requires maybe 10-20 hours a year.

score 0 · Answer 8 · answered Sep 14 '18 at 17:43

certain family members are pushing me to "get into" the stock market

If by

" ' getting in to the stock market ' "

they mean adding some money to an index fund every month - sure that's a great idea.

If by

" ' getting in to the stock market ' "

they mean you should start, snicker, "trading" (ie: you get a trading account, put in $50,000, and start betting on sticks going up and down),

that is:

a bad idea.

If you want to "get this out of your system" the best thing is to just try it.

If you put in "$50,000" it will cost you .. $50,000 .. but it will be out of your system.

And it will only take a couple months of your time.

An interesting observation: anyone I've ever met who has had this urge to "trade!" ...... has always done it. No exceptions. If you do have this urge, I would urge you to just jump in and get it over with. It will only cost you say 50 grand and that will be the end of it. It's a weird thing - some people just have the gene, the mindset, and they have to give it a go. If this is you, to repeat, I'd suggest just jump in, and get it over with.

(If it's just your family/friends suggesting this, just be polite and ignore them.)

Can a casual investor effectively predict the direction of the stock market?

8 Answers8