Can Anyone Predict the Stock Market?

Can Anyone Predict the Stock Market? Every investment you make comes with some amount of risk. This is especially true in the stock market. Equities, commodities, options, and exchange-traded funds (ETFs) can help investors accrue small fortunes or they can completely tank.

Conceptually, risk equals reward. While the relationship between the two is not linear, it is necessary. No one can truly predict the stock market, but that doesn’t mean that there are not trends to identify and exploit. You just have to know what to watch.

Predicting the Stock Market Is Hard

When the market crashed to its lows on March 23, 2020, top-tier research teams like Goldman Sachs predicted the S&P 500 would end the year at 2,400, but within a couple of months the NASDAQ hit all-time highs. The point is that nobody can predict the stock market because it is inefficient.

A market or stock that is efficient is one that is priced at its true value. The efficient market hypothesis (EMH), or as it is sometimes called efficient market theory (EMT), says that stock prices reflect all the available information on a company and so the share price is an accurate assessment of the company’s value.

Any advantage would come from insider info (which we do not recommend) or luck and any gains come from company activities.

However, the markets are inefficient because there are many factors that influence stock prices that have nothing to do with the company itself.

One investor may take a bullish view of the economy while another is bearish. Some investors may anticipate an advantageous market while others are encouraged by a change in company leadership, the release of a new product by say Microsoft or some other company, or their interpretation of the company’s relationships their suppliers.

Investors “win” by exploiting these market inefficiencies. They may choose to buy a stock that the market is pricing below its true value or sell a stock that is trading high on momentum.

For instance, sometimes an investor sees a stock price popping, so he or she buys shares in that company – they do and so do hundreds or thousands of other investors.

With everyone buying in, the share price keeps rising. Eventually, the price goes high enough that investors start to cash in. The share price starts falling and the price “corrects,” moving it closer to the consensus value of the stock.

Stock Market Crashes Echo Across Time

While it’s not possible to predict the stock market, its movements do tend to echo over time. For example, during the Great Depression, after the first crash, the stock market rebounded over 40% before ultimately declining almost 90% some years later, will it be different this time?

That is hard to say. There are also some parallels. From February to March 2020, the S&P 500 jumped 400% – then COVID-19 took hold. By March 23, the index had dipped 34%.

Those losses were short-lived. Many investors became bullish on the fate of the markets after countries and states began to implement guidelines to prevent its spread. By the end of April, the S&P 500 rose 32% and the Dow wasn’t far behind it. This offset over half of the previous loss.

This trajectory wasn’t that much different than the rally that preceded the Great Depression. Add to that the combination of 40 million unemployed people, a pandemic, and rising violence, and the economy may be at greater risk than the stock market indicates.

There are also some big differences. The stock market at the time of the Great Depression looked very different compared to today’s market – the companies alone are extremely different. Similarly, investors have changed.

Whereas the early 20th century saw more institutional investors, many more people invest in the stock market these days. Those factors may influence how the market reacts.

Leaving our current predicament aside, paying attention to the way the market moved in previous downturns can help provide some insight into what is likely going forward.

How to Predict the Stock Market

There is no crystal ball, but watching different indicators help to navigate the choppy waters. For instance, when the VIX rises above 50, historically, it has been a good time to buy.

Likewise, when oscillators like RSI and MACD are overbought, it’s historically at time of greater risk to be long. Also, when the Fed is engaged in QE, it is hard to stay bearish. Paying attention to these measures may help.

Many investors also like to pay attention to other indicators. Looking at the 10-day moving average can help see if a particular stock is overbought.

Comparing advancing shares to declining shares provides insights into an index. The short ratio may also come into play too.

Many investors like to monitor the economic calendar as well as factors relating to sentiment. The former shows the growth of different economic indicators and compares those figures to consensus estimates (e.g., housing starts, jobless claims, retail sales).

The latter includes volatility indices, puts compared to calls, price-to-book value, and price-to-earnings. However, investors should take those indicators with a grain of salt if they do not have a strong understanding of stock indicators specifically and economics in general.

Can Anyone Predict the Stock Market?

No one can predict the stock market, but there are signposts along the way, like those described above, that can help to identify when risk is higher or lower.

Many investors use these cues to decide when to put more or less money to work. After all, generating returns is not what counts, rather generating risk-adjusted returns is what separates the average investor from the professional investor.

Take some of these stock market predictors and add them to your existing due diligence. Think of monitoring these elements as tools in your toolbox, but they should not be the only elements you consider. Always keep in mind that the stock market is inefficient and unpredictable, so do your research.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.