Let’s face it,  deciding which stocks to buy is difficult. Period. Even those that do it professionally find it challenging and don’t always get it right. We know that markets aren’t 100% efficient (meaning that mispricings happen) but there are still plenty of reasons why stock pickers could get it wrong and often do.

Risks related to single stocks are numerous and notoriously difficult to handle. Anything from fraud (the Enron debacle) to a CEO resigning or geopolitical tensions could derail your investment. This is why predicting the future returns on any single stock is so difficult. Mark Twain said: “It is difficult to make predictions, particularly about the future”. This doesn’t, however, stop traders, analysts and financial journalists from doing just that. The stocks they tout may go down, or bust, or move sideways or up but you don’t know before taking the risk.

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Science has shown us how it is impossible to predict the movements of one single gas particle. However, it is possible to mathematically model and predict how a large number of those particles are likely to move. Those that have specialised in fluid dynamics (yes, the study of gases is included in this field) have been in high demand lately as the spread of coronavirus through breathing and air is under intense study around the world.

The principle applies to humans too. It is much easier to predict what a vast number of people will do than trying to foresee what someone off the street is going to say or do. This is why opinion polls are so popular before elections. 

Now, the price action in stock markets might seem mystic but it really is all about human intentions and reactions. Behind every price tick is the same common factor: human decision making. Yes, there are computers trading the markets but even these trading programs are controlled by human inputs. Someone has programmed the trading models that move the markets.

Therefore, the conclusion is that the same scientific principle applies to stock markets too.

This is a highly important and really helpful insight that can increase our probabilities greatly. The solution is to buy the index or create a portfolio of indices rather than to place your bets on two or three stocks and then hope they will go higher.

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If the broad indices like S&P 500, Nasdaq and Russell 2000 are moving higher in an orderly fashion (making higher lows and higher highs), then the likelihood of each of these indices moving higher is significant. Obviously, like always with the markets, making a bet that is safer (of higher probability) is likely to create a smaller return than getting it right and being the investor who buys the GameStop shares at lows and sells near the highs. This is an extreme example but it highlights the point.

The probabilities of you knowing the future are mighty low (to put it mildly) and getting it right with a small number of single stocks holdings pretty much much a low probability event. However, by making a bet with the indices tremendously improves your chances of making a decent return. If you want to learn more about trading and investing, join us for our free monthly webinars.

Don’t dive into trading without a good understanding of the basics. TIOmarkets is committed to helping you to learn and develop yourself as a trader. This is why I run free webinars on monthly basis. You can also find other education material at TIOmarkets.com Go to TIOmarkets.com/webinars to register for our next Live Trading Strategy Workshop for free. I will be there to teach you and share from my 20+ years of experience in markets and trading. Also, if you haven’t yet done so open a VIP Black account with TIOmarkets. You will get a great trading environment with tight spreads and no monthly subscription or per-trade fees. Register here: TIOmarkets.com

Trade Safe,

Janne Muta
Chief Market Analyst
TIOmarkets

TIOmarkets offers exclusively consultancy-free service. The views expressed in this blog are our opinions only and made available purely for educational and marketing purposes and do NOT constitute advice or investment recommendation (and should not be considered as such) and do not in any way constitute an invitation to acquire any financial instrument or product. TIOmarkets and it’s affiliates and consultants are not liable for any damages that may be caused by individual comments or statements by TIOmarkets analysis and assumes no liability with respect to the completeness and correctness of the content presented. The investor is solely responsible for the risk of his/her investment decisions.

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