Philosophical Musings

December 23, 2008

Stock Market Prediction Services – Caveat Emptor

Filed under: investing — Elad Kehat @ 10:07 pm

Services that offer to assist investors in predicting the behavior of capital markets always make me lough. The exact nature of the method du jour is not important; be it charting (that has idiotically become mainstream) or the new new thing – tapping into the wisdom of the crowds as captured online (see for example StockMood, and most activity on prediction markets such as AskMarkets). Either way, the subscriber to such a service is unlikely to profit from it.
The reason is not some inherent flaw of the methods used for prediction, but rather a simple human reasoning. I know because I dabbled in an attempt to develop such a method myself (with a little help from my friends). The idea was to mine online investor generated content in search of correlations between some of its properties and future market movements. We were unsuccessful at the time, but I shall not expand more on the details of the attempt, as I have not given up hope entirely – and that (as shall become clear momentarily) is the whole point of this post.
I dubbed our attempt “The Money Printer Project”, since should it have been successful, we would have had a machine in our hands that is equivalent to a (legal) printer of dollar bills. After all, if you develop a method to predict how stock prices will change before they actually do, at a better than random probability, you will most likely making a lot of money using it. (Only most likely because there is also the likelyhood of you ignoring the math and using emotion, thus making stupid mistakes and losing.)
Of course, if your method became known and popular, it will cease to be useful, as others will be able to predict your actions and either preempt you or simply trade against you. You can rely on larger financial institutions, as well as investors bigger than yourself, to have greater resources, access to greater computing power, and the ability to execute trade faster and cheaper than you. There is no for you to win against them, so your game must not be known – you have to be the only player playing that game.
Assuming that anyone intelligent enough to develop such a method also realizes the points above, they would never offer their method to others. The only reason to offer this method is if it doesn’t really work. There are enough gullible investors out there that can be impressed by a sophisticated (yet false) prediction model. It is far easier to succumb to greed than to try and falsify such a model scientifically.
In other words, if someone offers you a system that can help you predict capital markets they are probably lying. If it was indeed successful, they would have used it themselves. If they sell its predictions instead, it is most likely because that is the only way to make money out of it.

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