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Stocks Rose Sharply on Wednesday Because …

By John Price, Ph.D.

Every day we see articles in the press and hear the pundits on television telling us why the stock market did something. But it is always about why it did it yesterday. Why it went up, or down, yesterday. Or last week. Or last year.

Rarely about what it is going to do tomorrow. Or next week. Or next year. Not even over the next minute. And when they do make such forecasts, we would be wise to ignore them.

Why? Because no one can make these types of predictions.

Here are a few comments I read recently. “Investors are not focusing on what companies are reporting now, but on their outlook.” “Stocks rose sharply on Wednesday as investors bet the U.S. economic recovery is picking up steam.”

This is like saying that it took me less time to get to the office today because I had fewer red lights.

Could I forecast that I was going to get fewer red lights? No. Or in the stock market, could I have forecast that investors are now going to focus more on the outlook of company reports? No. How would I even know that they were doing this? And if I did, would this tell me what the market was going to do? No.

Could I have forecast that investors will start betting that “the U.S. economic recovery is picking up steam”? Of course not.

We are very wise after the event. We can easily invent reasons for past events. We can speak oh so knowledgeably about past market behavior.

The seduction of this is that we start to think we can apply these reasons to the future. We are led into thinking that we know what we are talking about when it comes to future directions of the market.

Even worse, we think that the newspaper writers who rabbit on about these things know what they are talking about.

Well, actually, there is something worse. “Investing” your money based on these articles.

“I never attempt to make money on the stock market.” Buffett said back in 1983. And Buffett loves making money. If he is not trying to predict what the market is going to do, we can be confident that he does not believe that it can be done.

Continuing, he explained his attitude towards the market. “I buy on the assumption that they could close the market the next day and not reopen it for five years.”

In the short term, Benjamin Graham explained back in 1934, the market is driven “by artificial manipulation or distorted by psychological excesses”.

The great economist John Maynard Keynes expressed similar views. He did not try to figure out what the market was going to do. He focused on “a careful selection of a few companies having regard to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time.”

Most market commentators spend their lives looking in the rear-view mirror. Yet they write as if this gives them a clear view of the road ahead. If you want to avoid being another market casualty, don’t be one of their passengers. And don’t invest that way yourself.

There are two other major dangers of reading too may articles by market commentators. The first is that you might begin to think that we can compare the stock market to a physical system. This is implied through comments such as “the Australian dollar is losing momentum”

Cars have momentum. Planets have momentum. The price of stocks does not have momentum. There is no evidence, for example, that if the price of a stock goes up four days in row that it will go up on the fifth day.

The second danger is thinking that asset prices are living entities. I read recently that “the dollar is wallowing and looking for a direction.” This sort of writing can subtly lead you into thinking that all you have to do is study the asset prices looking for its habits and behavioral patterns.

Just a turn of speech you say. Perhaps. I am not so sure. In any case, finding quality stocks at attractive prices is tough enough. It makes things even tougher when it is muddled with a writing style that deliberately blurs the distinction between an asset price and a pig in a mud puddle.

Successful investing, as opposed to speculation, requires the careful selection of quality companies selling at attractive prices. This is the core of my software Conscious Investor. Scanning through thousands of stocks looking for those key companies that are likely to make you money year after year.

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