Why predictions are dangerous in Stock Trading

Updated: Nov 19

Trading without prediction is the key to success

Why Predictions Are Dangerous in Stock Trading

People take pride in being able to predict what will happen next. Sometimes they get it right, while other times they don’t. The problem with predictions and getting them right is it ends up fuelling people’s egos even when they get it right by chance. This also leads to poor decision habit.

For example, there will always be times when you bought a stock looking at some parameter, and it started doing well from the moment you bought it. The probability says this won't happen all the time and you might have gotten lucky. However, this could lead you to dangerously overestimate your ability and skill whilst increasing your risk, expecting the same results each time.

The same is the case with predictions. The probability of you predicting a coin toss correctly will always be fifty percent, regardless if heads landed 10 times in a row, there is still a 50% chance of either on the following toss. Its a game you simply can't predict for each individual toss (the coin has no memory).

A video on probability below and may be of use.

Predictions can be devastating in trading as they make you stubborn and rigid with your positions. This ends up directly interfering with the risk management aspect of trading. Here are a few pointers on why predicting can be further detrimental for your trading career.

It interferes with your trading discipline

The most important factor that predictions impact directly is your trading discipline. If you have traded for a while, you will know that trading is quite dynamic and it never moves in a smooth flow.

There is volatility that you have to contend with and you need to have an exhaustive rule book for all kinds of trading situations. Even then, you won't be right all the time. In fact, you could be wrong more than you are right. That’s the likely outcome even after significant hard work and discipline.

When you have formed a view about something in trading, there is always a possibility that you skip following the rules for that 'one' time. That’s sinful in trading because that one time becomes two and several more pretty quickly. If you know you shouldn't do it, don't do it.

An accumulation of these exceptions can quickly deplete your trading capital, pushing you to the side-lines and out of the market, often forever.

The best strategy is to always have objective thinking while trading. You must also take each trade completely independently of the previous trade(s) while following your plan diligently.

No matter how strongly you feel about the trade, you should go in with a stop loss and get out of the trade as soon as the price hits your stop loss (assuming its a trade and not an investment). Similarly, you must position size based on the risk involved in the trade and not on how you feel about the trade.