Currently one can read in various media reports that international markets are going through times of uncertainty, mainly due to the slowdown in China, slowing growth in the US in late 2014, problems in the Eurozone, among other situations. In this context the phrase can be heard: “If it was obvious the market was going to go up, then why not invested if it was so clear?”
Given these current situations where the market can take various positions, it is best to try to understand and analyze past movements in order to make a better decision on future investments. However, this will not always be successful because in the end, the market movements cannot be accurately predicted.
For a better understanding, let’s look at a little thought experiment that took place in the US.
In a university psychology class, students were separated into two groups. The groups were told that during colonial times, the British invaded Africa, and a confrontation between British and Zulu natives took place.
At this time the British had the advantage of firearms while Africans do not, and they asked the first group of students which camp was more likely to win. After a few minutes of analysis, the group concluded that while the British had guns, they did not know the territory as the native Africans did, and they concluded that the odds were 50-50.
The second group of students were told the same story, and the instructor added that the Zulus won this battle over the British invaders. The response from this group of students was that it was “obvious” that result because they were a larger force and knew the territory well. While the second group, knowing what actually happened, thought the Zulu victory was “obvious,” the first group – not knowing the real result of the battle – put the odds at 50-50.
This same scenario but with more variables take place in the financial markets. These variables explain in detail the foundation of crises or economic miracles once they have already occurred. In hindsight, what has already happened seems “obvious,” but in the financial world, without prior knowledge, a potential investment opportunity is missed.
But do not feel bad, because even the biggest market experts who have extensive knowledge of the past occurrences – when it comes time to make sound investment decisions – they cannot remove all uncertainty.
In my experience as a trader, I have learned and trade by 3 basic rules:
1. Before investing, always develop an investment plan. Though this seems basic, I have met many people who make investments without putting a measurable goal. Many invest without even identifying which markets they should invest in.
2. Do not blindly believe in market opportunities that seem obvious. As much one becomes an expert and knows the past, this does not ensure that you will have complete success in trying to predict the future. It’s easy to say something was “obvious” after it has happened, but at present it is not easy since you cannot predict with 100 percent probability of what will happen in the financial markets.
3. No one is always right in financial markets. A couple of years ago, the vast majority of analysts predicted that the price of gold would reach $2,200 USD, and that a share in Apple would be worth $800 USD. Remember that nobody has a crystal ball to predict the market with 100 percent certainty. The best practice is to analyze and assign probabilities depending on the market you are investing in.
A common mistake made by many investors and traders is to maintain a losing investment position with the hope that the price will rebound. Many simply can’t accept that their initial market analysis is not correct, and even worse, some to pretend to be right in the market even when taking a loss. Remember that one cannot go against the market and always be right. As much as possible, try to maintain a healthy relationship between risk/benefit so that the possible gain is greater than the amount of risk you’re willing to assume.