(Un)predictable

Lots of investors and investment experts try to make predictions about the stock market. For their predictions, they use technical analysis or predictions about specific shares. But can predictions about the stock market be made? Or is it impossible to make predictions about the prices of specific shares? In this article I will explain how (un)predictable the stock market really is.

Unpredictable

A few reasons, about why the stock market is unpredictable, exist. These reasons are that the prices are adjusted for all available information and the absence of a cause-effect relationship. In this part, I will discuss these reasons.

The first reason why the stock market is unpredictable, is because the prices of shares are already adjusted for the available information. This information may include financial information of a company (such as earnings), but also news. When new information is communicated to the market, this information will be included in the price immediately. This means that the price of a share consists of all available information and the expectations of investors. Fact is that expectations are not equal to reality. This is why an expectation does not count as a prediction.

The second reason why it is impossible to make predictions about the stock market, is the absence of a cause-effect relationship. In physics, laws are established about mixing chemicals causing, for example, a certain reaction. For these laws, a strict cause-effect relationship exist. In the stock market, there are no established rules. If situation A happens, you can by no means say for certain what happens next.

The absence of the cause-effect relationship, in combination with the available information, causes the unpredictability of the stock market.

Predictable

On the other side, there are also reasons to think of why the stock market is predictable. These reasons are technical analysis, being part of a group and the self-fulfilling prophecy.

A lot of investors use technical analysis to determine in which company they will invest in. Technical analysis can be used as a prediction tool, because a lot of investors use this method. Because variables and formulas that are used for technical analysis are fixed, the results of these analysis are also fixed. The reaction following these results of the technical analysis, will thus generally be the same for every investor. This is why the stock market is a little predictable, because the reaction of the investors are predictable.

The second reason why the stock market is predictable is that people (and especially investors) want to be part of a group. Because investors follow the stock market, they will react on what happens on the stock market. For example, if a share is being sold a lot and the price is going south, also other investors will start selling the specific share. This speeds up the decline of the price of the share.

The last reason why the stock market is more predictable, is the self-fulfilling prophecy. Investors are very prepared to listen to investment experts. They will listen to these investment experts because they think that these experts have more knowledge about investing and may have access to better information. If an investment expert has a certain authority and influence, investors will follow up the advice of the experts. This means that the share price will react to a statement of an expert, just because an investment expert has said it.

The above reasons indicate that it is not easy to say whether it is possible to predict the stock market or not. To a large extent, the stock market cannot be predicted, but because of the "social" behavior of investors', predictions can come true.