Seeing Patterns Where None Exist

Although some very bright people may try to convince you otherwise, the investment marketplace follows no predictable patterns. If it did, the so-called experts would tell you exactly what and when to buy and sell, and you’d never have to worry about money again.

To better illustrate the difficulty of predicting market moves, let’s take a closer look at typical investor logic, using the parallels between gamblers and investors who try to time the market. Like many investors, gamblers tend to rely on hunches and perceived patterns to determine their next move.

For example, a person flipping a coin who gets ‘heads’ five times in a row might believe there is an increased probability that the coin would land on ‘tails’ with the next toss. Others may think that ‘heads’ is on a hot streak and believe it is more likely for that to continue. But in fact, the odds of the next toss being ‘heads’ or ‘tails’ is 50/50 – no different than for any coin flip.

Investors tend to take similar approaches to the stock market. Rather than setting a strategy, they are often gambling on a certain streak, typically one they believe is going to continue. For example, in the early 1990s, investors bought billions of dollars in vastly overpriced dot-com stocks, simply betting those stocks would continue to move dramatically higher. Ultimately, that market crashed and investors holding those stocks were saddled with significant losses.

More recently, the real estate market seemed to be on an endless upward cycle; people bought property, and counted on the value endlessly climbing. But in the past few years, that myth was exposed, and the real estate market tumbled along with economy as a whole.

The lesson here for investors is to realize that we have a human tendency is to see patterns where none exist, and to ignore those perceived investing patterns. With this awareness, one can increase the probability of investing success by avoiding the guesswork of active management, and establishing a very low-cost and diversified portfolio that can perform well in many different types of markets.