Prediction vs Conviction

The stock markets have been choppy for the last several weeks. This after falling around -20% over the first half of the year. As we know markets do not move in a straight line. So, how do we know what the market is going to do next?

My answer is I do not know. I can say for sure what has happened. I cannot say why it happened. And I cannot say what will happen next. I think most people are like that. They cannot say what will happen next. Yet, we all have to take a stance and take actions based on what we “feel” will happen.

So, the question really is on what basis do we feel and what is the strength of our feeling? If we are accustomed to making predictions and taking actions based on the fear or greed we feel, it may turn out to be detrimental to our financial well-being.

The worse situation could end up being the one where our prediction was right. Because we can all be right one time or a few times, we may end up getting a sense of talent for predicting the stock markets.

There is a thing about “going with the gut” and some people do have an innate talent to be right more often than not. Unfortunately, I am not one of them. And fortunately, I know I am not one of them.

I recommend that everyone playing the stock market should decide who they are. If they are good at predicting and have seen their predictions to be right more than half the time, then that could be their chosen model.

I needed something that works better for me than my predictions. I needed a “system” that is proven to give me a greater than 50% chance to be right if I take actions based on this system. I needed data to prove out the system.

I tried several systems for several years. I performed back-testing on these systems (automated and manual) and finally settled on the concept of trend-following that I now use to take actions in the market.

Trend-following is a technical analysis method where actions are taken based on various trends seen in the markets. This is a well-established system, and several wall-street companies use this - especially the quant funds.

Within trend-following though, one still has to decide what is the specific system they will use. What is “their” system? What is the system that drives enough conviction that actions can be taken using that system unemotionally?

Over the last 3 years I have developed this system for myself. It works for me as long as I do the work and follow the system. As long as I am disciplined and do not get emotionally caught up with fear or greed.

Note that when I say it works me, I do not mean it works for me all the time. It works for me more often than not and definitely more than half the time. And I can keep trying to improve upon the results through an approach of continuous improvement.

I talked about discipline and emotions above. Unfortunately, and fortunately, I have had several occasions when I have acted without following the system rules that I developed for myself. The anger I felt upon myself in those situations now is a reminder to dissuade me from doing that in the future.

So, as we face these choppy markets and uncertain times, I am able to stay calm and just use my defined system to tell me what I should do. And it is based on the conviction I have on the system that I have developed.