How to get the stock market right 6 months in a row

Imagine receiving a letter at the start of the month predicting that the stock market will rise. Just another cold sell so you bin it and probably won’t recall it when the market does indeed rise. Then the next month a similar letter is received but this time it says the market will fall. This time when it falls maybe you will remember the letter? Now lets say that this continues every month. A letter arrives and correctly predicts the direction of the stock market. Would you not start to think that there was someone very clever behind these letters? And how many months would need to go by before you gave him your money to invest?

However after you have invested and your money is largely gone and lost you sit down and ask how could I be so wrong? The answer is that you fell victim to ignoring the silent witnesses. This is how it works.

Take the names and addresses of 10,000 people. Mail 5,000 saying the market will rise and 5,000 saying the market will fall. Next month repeat the 50/50 split but only mail those who got the letter which made the correct prediction in the previous mailing. Repeat monthly until you have a much reduced list of people who have always received the correct forecast. Basically when you sit down having received the correct forecast for the last 6 months then out of the 10,000 which were mailed initially there are now 312 who like you are thinking they are onto something good. The other 9,688 are the silent witnesses. They all received a letter where the forecast was wrong but you don’t know about them. They are the silent witnesses.

This problem also goes under the name of the survivorship bias and was highlighted by Nassim Nicholas Taleb in his highly provocative book “The Black Swan”.

So where else does this crop up in life? Well in his book he argues that this is one of the main drivers which brings the problem of Black Swans and unexpected disasters into our lives. But on a more mundane level he also suggests that this lack of insight, so that we only see what we want to see, also impacts on areas as diverse as the nature v nuture debate and the illusion of skills in many professions.

These are powerful arguments and we will investigate them in further blogs.

Written exclusively for financewand by Mike Holly. Mike lives and works in Northumberland, United Kingdom. Referring you my friend’s site on  Currency trading strategy