Forecasting The Market Is All Wrong

by: Rob Husky

With the market hitting new highs, there is increasing press coverage about whether to get in or out of stocks at this juncture, and what it takes to be successful.

On his blog, J.J. Zhang makes a case that your chances of beating the market are 50:50. (See his March 4th post.)

Mark Hulbert on MarketWatch looks at the VIX as an indicator to help foretell when the market has gone too far and when to get out. He concludes two popular ways of using the VIX do not lead to a profitable advantage. He also has looked at using the 200day MA as a technical indicator for timing and comes to essentially the same conclusion.

Lastly, Walt Bettinger, the CEO of Charles Schwab, points out in an article yesterday "...unfortunately no one has found the crystal ball that accurately predicts when tops and bottoms have arrived."

These guys are right, which leads me to my point: success in the market is not predicated on forecasting skill to any significant degree, nor relying on a 'magic' indicator to tell if a stock will go up. Valid indicators to forecast the market with significant reliability over the long term just don't exist.

So how does one do well in the market?

Many people completely misunderstand how to invest. I lied a minute ago when I said forecasting indicators don't exist - there is one but its effectiveness too far in the future is limited. It is the Trend. Trends exist and are the best indicator of future prices, at least in the short term.

I use the trend to get a small edge. I'll buy a stock when both the broad market and the individual stock are trending well. My goal is to show a small profit quickly, then let luck take over. Yes, luck. Once my stock moves up into the Black about the same amount as my initial stop-loss, I raise my stop-loss to the break even point and let the stock do as it will. If it falls back to the point I entered, I get out even and not let a gain turn into a loss. If price continues higher, I raise my stop-loss along the way to protect the potential profit - aka letting your profits run.

Investing success is not finding a mystical formula of indicators that provide an accurate forecast of future higher prices. The method is to gain a positive probability of price moving higher for a short time, use risk management to exit if price falls back down, and repeat many, many times. So all this discussion about whether the market is topping or just starting a bull run is just entertainment. No one knows. Just follow the trend and use risk management to stay in stocks that go up and get out if they go down.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.