Originally published June 2005


The Folly of Forecasting
Barry Ritholtz
The Street.com
06/07/05 – 01:05 PM EDT


As a chartered member of the chattering class, I am all too familiar with the “perils of predictions.” Anyone who works in the financial field and speaks to the press eventually gets tagged for a market forecast gone awry. It’s an occupational hazard.

Unfortunately, investors all too often give these “predictions” in print or on TV far more weight than they should. It’s very easy for a confident-sounding analyst, fund manager or professor to say something on TV that can throw off the best laid plans of investors.

I wish an SEC-mandated disclosure accompanied all pundit forecasts: “The undersigned states that he has no idea what’s going to happen in the future, and hereby declares that this prediction is merely a wildly unsupported speculation.”

Don’t hold your breath waiting for that to happen.

The bottom line is that I’ve yet to find anyone who can accurately and consistently forecast the market behavior with any degree of accuracy, beyond short-term trend following. That inconvenient factoid never seems to dissuade the prophets — or the press — from their fortune-telling ways.

There are a few things that investors should keep in mind when encountering these speculations. Whenever you find yourself reading (or watching) someone who tells you where a stock or the markets are going, consider these factors:

  • No one truly knows what tomorrow will bring. Nobody. Any and all forecasts are, at best, educated guesses.
  • All prognostications are instantly stale, subject to further revision. Conditions change, new data are released, events unfold. Yesterday’s prediction can be undone by tomorrow’s press release.
  • In order to “become right,” some investors will stand by their predictions despite a stock or the market going the opposite way, hoping to be proven correct. Ned Davis called this the curse of “being right rather than making money.”There are only two kinds of predictions that have some value to investors: One is probability-based, and the other is risk-based. As long as you apply the same rules — no one knows the future, they are subject to revision and should not be taken as gospel — then these are sometimes worth considering.Probability assessments are typically based upon historical comparisons of prior markets with similar characteristics: The more variables that align, the higher the likelihood that a given scenario plays out in a similar fashion. They are of this variety: In the past, when X, Y and Z all happened together, then we expect that A is most likely, then B is possible, while C is the least likely.That doesn’t mean A will happen or C cannot — only that there’s a specific probability of these events occurring out of the millions of ways the future might unfold. Whether any particular scenario plays out is determined by how the countless variables interact over time.

    Looking at the future in terms of various probabilities is a productive way to position assets and manage risk. Why? If your expectations for the future recognize that this is but one possible outcome, then you are more likely to consider and plan for other contingencies. It builds in an expectation that other scenarios can and will occur.

    For example, one signal I use is to determine when to sell (the subject of a future column) is after a long uptrend is broken. It’s not that stocks cannot go higher after breaking their trend line — they sometimes do. However, most of the time this happens it signals a significant change in institutional behavior towards the stock. Typically, it reflects a shift from fund accumulation to distribution.

    For those people who have been enjoying the ride in Google (GOOG) — especially the near vertical move since April — this is a high probability strategy. Once that trend line gets broken, say adios muchachos, take your profits and move along.

    Again, a trend break is not a guarantee that the upside is finished, but it’s a fairly good probability assessment.

    The second type of good prediction is the risk-based discussion. These forecasts care less about price targets — instead, they are an assessment of danger. In other words, to buyers of stocks under the present conditions, when this, that and the other are happening, you are taking on more (or less risk) than is typical. Saying the markets contain more or less risk at given times is a very different statement than: “I think the Dow is going to go to X.”

    I engaged in a combination of broader market-based probability this week in Smart Money, along with future risk assessment. Given the change in character the market displayed since the April lows, I noted the high probability of a substantial rally in the second half of the year. My basis for this was part technical — the market regaining its prior trading range — and part anecdotal (all the hedge fund cash on the sidelines). This created a high probability of a move similar to what we saw over the summer of 2003.

    But I also included a risk-based assessment based upon the age of this bull move, along with the decaying macroeconomic environment; in tandem, they set up an increasing risk environment as the year progresses. That’s how a top can form, and that presents an increased risk of a market correction or even collapse.

    When you stop to consider all of the unforeseen actions that might occur between now and then, however, it becomes pretty apparent that all forecasting is at best a low probability activity.

    Chaos Theory

    Why are the markets so difficult to predict? To borrow a phrase from the physicists, the market demonstrates “unstable aperiodic behavior in deterministic nonlinear dynamism.”

    This behavior is better known as Chaos Theory.

    What does that mean in English? The market is called “aperiodic” because it never repeats itself precisely the same way. Weather is also aperiodic — it may be colder in the winter than in the summer, so there is a degree of cyclicality. But the day-to-day changes are never exactly the same year after year. The same dynamic applies to the markets: There are similarities from one era to another, but it’s never identical. In Mark Twain’s words, “History doesn’t repeat, but it rhymes.”

    The markets also act with a surprising degree of instability. Small forces can create disproportionately large reactions. A surprising economic report, an off-the-cuff comment by a Fed official, a small change in earnings by any one of 1,000 companies; any one of these data points can roil the market. That behavior does not occur in what the scientists call “stable” systems.

    Given the complexity of both the capital markets and the physical universe, we shouldn’t be that surprised that Chaos Theory is so applicable to the financial markets.

    Considering how little we know about the totality of market conditions — and how incredibly intricate and complex the system is — it’s no surprise that pundit predictions are so frequently poor.

  • Category: Apprenticed Investor

    Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

    19 Responses to “Apprenticed Investor: The Folly of Forecasting”

    1. Space_Cowboy_NW says:

      Sorta OT [maybe]: As always…there are many pathways to a destination…your mileage might vary!


    2. kcowan says:

      I had a job for a Fortune 50 company where I had to create the plan for 1 year, 5 years and the forecast for 30 days. When we would get the forecast wrong, I would retort that forecasting is easy but if I could predict the future, I sure as hell would not be working here.

    3. gd says:

      And sometimes the facts themselves are questionable:


      History doesn’t repeat itself, but it does rhyme.

      * This is very often attributed to Mark Twain, but is not found in his works. The earliest publication yet located is a verse which might involve a deliberate invocation of poetic license in John Robert Colombo’s poem, “A Said Poem”, published in Neo Poems (1970), which reads: “ ‘History never repeats itself but it rhymes,’ said Mark Twain.”


      The past does not repeat itself, but it rhymes.

      * Also quoted as “History does not repeat itself, It rhymes” and “History may not repeat itself, but it rhymes a lot.”
      * According to this notes on sourcing, Twain scholars agree that it sounds like something he would say, but they have been unable to find the actual quote in his writing.
      o Twain did write: “It is not worth while to try to keep history from repeating itself, for man’s character will always make the preventing of the repetitions impossible.” (Mark Twain in Eruption: Hitherto Unpublished Pages About Men and Events (1940), ed. Bernard DeVoto.)

    4. KJ Foehr says:

      Forecasting may have once been folly, but no longer, it seems.

      Economics used to be called the dismal science. And it was said economists could never agree on anything and all were wrong at least as often as right. But Ben has changed all that. Just look at his ability to forecast correctly. Just as he predicted in his paper on how to avoid another depression, simply by raining money he has been able to prevent a second Great Depression. He stopped the freefall in stocks and the economy; he blunted the freefall in housing. And he told us what would happen before he did it. Is this not accurate forecasting? He even said it would increase stock prices, and he was right. What is dismal about that? He has played the markets and economy like a violin.

      His forecasting has been impeccable: The stock market is up what, 80%, or something like that; corporate profits are at all-time highs, the GDP is increasing decently, unemployment has fallen and is expected to fall significantly more very soon.

      You said it yourself, “Don’t fight the Fed”. So what is so difficult about forecasting a market when Ben continues to pump liquidity at warp speed? It is simply “onward and upward!”

      And if he stops, we will know it, and then how hard will it be to forecast rising interest rates, a slumping stock market and a slowing economy?

      Lastly, earthquakes in Japan, and revolutions in the middle-east are just bumps in the road. They cannot be forecasted of course, but only represent surprise buying opportunities, as Warren himself pointed out.

      Actually, it is a piece of cake now , no?

      Free markets may be unpredictable, but controlled markets are not. (I think this is something like what used to be called a “planned market economy”.)

      Or, who needs forecasting when you got Ben?

    5. DL says:

      O.K., economic forecasting is folly. Fair enough.

      But that only begs the question, what to do with one’s money? Buy an index fund? Buy a sector fund? Give it to a money manager who’s no better at predicting the future than you are?

    6. queball says:

      @ K.J Foehr

      Nice post, well said and 100% dead on. At this rate, I am just wondering what the next “surprise buying opportunity” will be. Metoerite wipes out half a continent??? Just saying…

    7. whskyjack says:


      first , invest in a bottle of good whisky…….

    8. obsvr-1 says:

      whskyjack says:


      first , invest in a bottle of good whisky…….

      —- Reply: And remember in this case, buy and hold is not the strategy

    9. jb says:

      Thanks for explaining what may be obvious to some, but not to many of your “apprentice investors”.

    10. OscarWildeDog says:

      Thanks for reposting this article Barry – as timely now as it was then, although you are now “preaching to the choir” because all the dip-your-toe-in-the-water investors are out of the market, waiting for the long expected drop in the markets which have not come yet.

      You’re right – no one knows anything; one can only venture an (educated) guess. If you guys were right all the time, you’d be on the beach in Belize or your family estate in Turkey, right? So, all you can do is “play” the market as it was meant to be played… preferably hedged in some way. I prefer “delta neutral,” which takes into consideration any expected volatility. I play options, so I get out of a trade at the first sign of a shift. If one plans and executes this strategy as a business – as I’m sure you guys do in your business – you will make money more often than not because all you have to worry about are the gaps up or down caused by news or fear/greed. Since I always have a high and low spread on the same equity, as long as I am out of the poor performing side of the spread at a delta of, say .20 on the short option, I am guaranteed to make money.

      Bottom line: I listen to you guys, but I listen to myself more.

    11. ES says:

      So, then the only logical conclusion based on this thesis is that fundamental or macroinvestment strategies either cannot work or pure luck since they rely on predicting probability of future events. According to this thesis one has to rely on the concurrent information in the form of technical analysis to gain an edge or come up with a market neutral strategies instead of coming up with a hypothesis of what is the most probable or building protfolio aroud that. Yet, we have several quite successful macroinvestors ( Soros, for exmaple) . How did they do it then?

    12. icm63 says:

      Barry True, no body knows the future..

      Unless you have statistics on your side, then you have better odds of getting more right than wrong..

      85% success rate here : http://www.readtheticker.com/Pages/Blog1.aspx?65tf=155_dow-theory-with-hurst-cycles-2011-03

      100% success rate here: http://www.readtheticker.com/Pages/Blog1.aspx?65tf=140_timing-silver-prices-with-100-accuracy-2011-02

      Charles Nenner Dow call: http://www.readtheticker.com/Pages/Blog1.aspx?65tf=134_what-does-charles-nenner-see-when-he-said-dow-5000-by-2012-2011-02

      Cycle tools are your only hope of calculating future turning points

    13. socaljoe says:

      What one security will do tomorrow is unknown and unknowable, but due to the mean reverting nature of markets, what an entire asset class does over the long run is predictable with fairly high degree of certainty. Good thing we don’t have to get 100% right to be successful.

    14. BR,

      as, with others, above, these “Apprenticed Investor: “- articles are Gold.

      have yet to see one that hasn’t ‘held its Value’..

      this: “…For example, one signal I use is to determine when to sell (the subject of a future column) is after a long uptrend is broken…”, to me, seems one of the important takeaways..

      really, ‘Investors’ should learn that ‘when to Sell(?)’ can, often, be answered by a Crayon & a Straight-edge..

      and, re: Chaos Theory

      the, said same, ‘Investors’ should understand http://search.yippy.com/search?input-form=clusty-simple&v%3Asources=webplus&v%3Aproject=clusty&query=Put+Options+act+as+Insurance

    15. budhak0n says:

      Do you really want to delve into that? The last thing you want to do at this point is have wacky people trying to attach some duty of care to opinions.

      That’s a whole can of worms that’s better left the way it is. If people don’t know that the man or woman is simply expressing their personal viewpoint, or worse yet could be expressing one thing while they believe another possibility is more likely, then that’s on them.

      You’ve already got everybody flipped out about the general state of the “finance” industry. To have people searching for ways to attach faces and names to liability for what they actually said is a dangerous game.

      Heck we can’t even connect them for what they did most of the time lol.

      That’s part of the reason why I’m anti facebook.

      Wow some really strange “macro” outlooks in this thread.

    16. Charles Maley says:

      It is tough to make predictions, especially about the future. – YOGI BERRA

      Why Are We Such Suckers For Prediction?


    17. cognos says:

      Hmm… I kinda disagree.

      Long-term risk asset bulls have been good “forecasters”. The S&P500 was at about 150 in the early 80s. With dividends its up 15x.

      There have been 2 or 3 really cycle peaks… most notably dot-com bubble in 2000 and real estate bubble in 2007. IF one was able to step aside, or short key instuments (like oil in july 08) in the peak… then quickly return to buy the dip… 15x becomes 30x quite easily.

      So, if one just got off the “bullish” wagon 1x or 2x in the last 20-yrs… one was pretty close to the ultimate forecaster.

      Of course, there is much more money made by selecting specific investments… some of which can go up 10x during the worst of times… The best money managers have 20%, 30%, or even 40% long-term annual returns.

      So I think… it can be done.

    18. victor says:

      Good reading. I also recommend Nassim Taleb’s chapter in his book of Aphorisms titled “The Scandal of Prediction”. Randomness, Decisions and Human Nature rule. Once you understand the difference between risk and uncertainty you’re on the right path to investing. Ben Graham already told us all about this. I’m still struggling though ’cause, I confess” I still, from time to time, listen to this guru or that one.

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