There is no shortage of opinions about what the stock market will do next. At any time it is possible to find logical, compelling and astute arguments for why the market is likely to continue to run higher and for why it is doomed to a gut-wrenching correction. If you want to find an argument to confirm a particular market view, it is very easy to do so.
Developing a thesis about what the market will do in the weeks and months ahead is helpful. It provides a framework for strategy. If we have a bullish thesis, we can put more effort into finding the right long positions. If we have a bearish thesis, we can focus on exit points and short sales. However, there are dangers when we become too committed to a particular view of the market. It can impede our flexibility and cloud our objectivity, but it also provides a framework for a plan of attack.
When developing a market thesis, there are a number of issues we must consider:
- It is thesis, not a certainty. The market almost never develops the way that people think it will. There is no question that the current market will eventually undergo a painful correction, but it is arrogant to believe it is possible to predict how that correction will unfold. In many cases, the ultimate causes of a market move are totally different than what was expected. Be ready to adapt as events take place
- A market thesis is a process. There is new information every day that must be considered. How would a half-point cut by the Fed or a China trade deal impact the way we view the market? At a minimum, it would have a big impact on timing or it could totally destroy a particular thesis.
- Timing is a key issue. Anyone can predict an eventual economic recession or a market correction. They are inevitable, but it is timing that matters most. If we predict a market correction but are months or years early, then it is as good as being wrong. One of the favorite tactics of market pundits is to keep predicting a market correction but to do it so often and so loudly that no one remembers when the initial prediction was made. As soon as there is a minor move downward the pundit proclaims success. The fact that the trade would still be a loser is totally ignored. A market thesis without timing is worthless.
- Don't data mine. One of the biggest dangers of formulating a market thesis is the inclination to only consider information that confirms an existing view. Quite often a pundit who never considers charts will start pointing to technical indicators to confirm their thesis, which is based on other factors. Bears will dismiss all positives and focus only on those things that advance their arguments.
- Consider the alternative view. There are highly intelligent and successful people on both sides of every trade. Not everyone who is on the other side of our trades is a fool who is overlooking painfully obvious factors that we see. Make an effort to formulate the thesis that the other side of a trade is making. Why don't they embrace the view that we hold? What is it they see that we might be missing?
- There is no shame in being wrong or changing your mind about the market. Our goal as traders isn't to seek glory for making great predictions. Our goal should be to develop strategies that allow us to make as much money as possible when we have a trade that is going our way. When you put ego ahead of profits you will have suboptimal results.
- Predictions in the media are just entertainment. Much of financial journalism is focused on stories that attract attention. One of the best ways to generate attention is to make very sensational predictions such as "Why a Crash Will Occur Before the End of the Year." This sort of thing should not drive us to take action. It might be interesting, but it always lacks effective strategies and timing. It can be valuable to consider some new information, but make sure you consider it in the context of a much bigger thesis.
The biggest mistake most market players make is to focus too much on predictions and not enough on developing a strategy as events unfold. It is helpful to have a market thesis, but it should be flexible and always a work in process. The best results will be produced if you react to changing events rather than try to guess what will happen.