Oct 14, 20225 min read

Why predictions are dangerous in Stock Trading

Updated: Nov 19, 2022

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.

You must not let your predictive nature dominate your trading discipline. Conversely don't allow fear or hesitation to cloud your objective plan.

One of the best books for keeping a perfectly balanced psychology is Trading In The Zone. - The video below discusses the key aspects:

It dampens your reactionary skills

Trading is all about reacting to whatever the markets give to you.

When you are too opinionated, you won’t be able to react as quickly to various trading situations as you should. Most times, you will react much later, leading to potential trading losses or lost opportunities.

When you take trading as it comes and only react to the ever-evolving market, you achieve an objective state in trading. You cut your losses quickly, you ride your gains well, and steer clear of making impulsive ad hoc decisions.

I often post my personal equity curve from my trading strategy in these post, for no other reason than showing what can be achieved by following a plan rigidly. I go through good and bad times, but following the rules as mechanically as possible, allows me to be completely emotion free.

Nothing is more painful than seeing a trade go south and not being able to do anything about it. Opinions and predictions are never a solace for lost money in trading.

"Follow the plan and keep your risk in check, prediction and hope have no place in trading".

The priority for any trader, therefore, is to preserve capital and not opinions. The agility required in trading is best practiced when the trader acknowledges that he is just a small pawn in the overall scheme of things. A trader’s job is to profit from the market moves and not predict where the next move is going to be.

" we can react to information to improve probability, but we can never predict an outcome with certainty"

Facts change very quickly in markets and opinions always take time to readjust. Therefore, it pays to be reactive than predictive in markets.

It makes you overconfident

People tend to get overconfident about themselves when they get a few of their opinionated trades right. This brews a destructive quality that must not prosper in trading.

All successful traders see their careers go downhill when they become overconfident. If your opinions are feeding your overconfidence, it’s always a good idea to shed them and focus on the facts and probabilities.

There are many ways for overconfidence to creep in without you noticing it. For example, bull markets are the easiest source of overconfidence. In bull markets, you will always have a better win rate and make money. A good bull market performance makes you opinionated about your midas touch, those same opinions going into a bear market can be catastrophic.

Jeremy Lefevbre from the Financial Education channel is a fine example, he started after the financial crisis in 2008, made good gains in the bull market, became over confident in his approach, and has since lost most of it by applying the same approach in the bear market.

The sad part is that bull markets don’t last forever. If you fail to acknowledge the rising tide and credit yourself for all the bull market winnings, you will go into choppy and/or bear markets with the same confidence. That’s when it hits back and takes all that you made and much more.

The final word

More trading careers end because of rigid views and an ego for prediction than any other trading mishaps. The legendary trader Jesse Livermore famously said:

“the markets are never wrong, opinions often are”.

It has been proved time and again that the markets can surprise in more ways than you can imagine. Therefore, it’s always best to keep an open mind about the possibilities in all market conditions.

Money will take care of itself when you trade with utmost discipline. Let go of predictions and focus on probability instead.

My breakout strategy - 15 page rule book (PDF) is available for all members to use.