The pros can’t predict markets, and you probably can’t either
The next time you make a prediction about the stock market or the economy, write it down. Check back a year or two later and see how it worked out: on average, you are bound to be disappointed. Studies of the forecasting success of the best and brightest on Wall Street and among economists have found that even the pros have a dismal record in forecasting. If they can’t do it, why do we think we can?
For instance, the Federal Reserve Bank of Philadelphia has for years tracked the forecasts of inflation by professional economists.
Past is prologue
They consistently find that economists are pretty good at telling us what has recently happened, but are not good at predicting the future. Their predictions of inflation rates generally appear to be merely a function of recent inflation rates.
Other studies show that the average bond trader incorrectly forecasts the direction of yield changes and that stock analysts cannot forecast the trend in operating earnings.
One of the psychological factors involved in bad predictions is overconfidence. Studies have shown that we are not “well-calibrated” when making estimates.
Too often, we make an estimate based on a range and the actual answer lies far outside our range.
Test yourself
Try it yourself. Answer the following questions with a range (like 50 on the low end and 100 on the high). You should have confidence that 98% of the time the correct answer will fall within your range.
- What is the length of the Nile River?
- How many books are in the Old Testament?
- What is the diameter of the moon in miles?
- How deep is the ocean in feet?
Here are the answers: the Nile is 4,187 miles long, there are 39 books, the moon’s diameter is 2,167 miles, and the deepest known part of the ocean is 36,198 feet down.
Don’t feel bad if you didn’t get them all right: on a longer test, most professional forecasters failed.