Why You May Be Able to Predict the Market

Groups of ordinary citizens may be better at picking stocks than financial experts.

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Uncertain economic times bring out the worst in investors. The anxiety caused by market turbulence drives investors into the arms of financial experts all too willing to share their opinions on the direction of the markets or specific investments to bullet proof your portfolio.

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The conflicting views of James Altucher and Harry Dent illustrate the problem. Altucher is a self-styled financial pundit who is attractive to the media for his ability to make outrageous predictions. In a recent interview on Yahoo’s Daily Ticker, he confidently predicted the Dow would go to 20,000. Curiously, he advised investors to avoid stocks because they are too “hard” and “competitive” and the market is mostly a “scam".

A month earlier, also on Daily Ticker, Dent, a prolific author of financial books, gave a sharply different view. Dent’s crystal ball indicates the possibility of the Dow crashing to as low as 3,300. His pessimism extends to commodities. He advises investors to lighten up or sell oil, silver, and gold. His predictive powers extend to currency as well. He sees the dollar rising.

Investors are left to ponder whether Altucher or Dent is correct. That’s precisely the problem. Neither of these financial psychics has predictive abilities more accurate than you would expect from random chance. The difference between them and you is that they get to offer their views to a broader audience. Your own predictions are likely to be just as accurate as theirs.

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There is a group of investors that accurately assesses market conditions. It’s the only group worthy of your attention. Here’s the irony. You are part of that group.

James Surowiecki, author of The Wisdom of Crowds, found that, under the right circumstances, crowds can make estimates that are more accurate than the individual estimates of experts. Some requirements must be met in order for the assessments of crowds to be reliable. The crowd must represent diverse opinions and not be led by strong members of the group, as is often the case with investment clubs. The accuracy of the crowd’s estimate is surprising. Surowiecki gave an example of the crowd at a country fair being asked to guess the weight of an ox. The average of their guesses was more accurate than those of cattle experts.

There are millions of investors looking at all the available information about every publicly traded stock. This information is processed instantaneously and incorporated into the price of that stock. The collective wisdom of these investors, and that includes you, has determined a fair price for that stock at any given point in time. That price is neither too high nor too low. There are no mispriced stocks, which must be a shock to brokers who spend their days trying to persuade their clients they have uncovered a winner.

Once you accept that the wisdom of the crowd of investors is more accurate than the views of any individual investor or pundit, you can easily reject the notion that Altucher, Dent, or anyone else has a special insight into the markets that has eluded the scrutiny of all of these investors.

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Their predictions may turn out to be right or wrong, but it really doesn’t matter. They have no special skills. Relying on them, or on any broker or adviser who purports to have predictive powers, is sheer speculation, with an expected return of zero or less because of transaction costs. For a reliable source of market intelligence, start by looking into the mirror.

Dan Solin is a senior vice president of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011.