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Predicting the Market (incomplete)

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PostPosted: Sat Feb 18, 2006 5:14 pm    Post subject: Predicting the Market (incomplete) Reply with quote

Short-term trades (i.e. intraday and within four weeks) and long-term trades (i.e. over three months) are the most difficult to predict. However, intermediate-term trades (i.e. one to three months) are the most predictable.

There are too many random factors short-term to make accurate predictions. Over time, the stock market is "mean reverting." However, short-term trading is more of a "random walk," because there's not enough time for the market to revert towards the mean. A recent study by two University of California Finance Professors showed 82% of daytraders (who traded intraday) lost money within a year.

The stock market tends to rise over time. However, there's little information in the current time period to explain where the market will be in three months to many years in the future, or information adjusts to make it difficult to accurately predict where the market would be in a longer time period. Consequently, many one year market forecasts turn out to be way off. All that can be assumed is a market return can be made holding for a long-period of time, e.g. 30 years, or the return is dependent on what stocks were bought and when.

The predictability of the market is easiest one to three months out. The short-term and long-term random factors are minimal, and enough information in the current period exists to make an accurate forecast. Consequently, the potential return to risk ratio is highest on one to three month trades, because there's typically enough time to at least get your money back, if the forecast turns out not quite right, and money is at risk for less time than longer-term trades. Moreover, holding cash after completing an intermediate-term trade provides the opportunity to make another intermediate-term trade.

Money management is most important. Goals should be set. A feasible goal is 20% compounded return each quarter, which is over 100% a year. If that goal is met, then short-term trades can be considered. However, the expectation of total losses on short-term trades should be taken into account. Short-term trades are typically based on greed, because potential returns are huge. However, those trades often result in big losses.
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