Forecasting the weather has many similarities to investing in the stock market. How many times has the weather changed and the forecast wasn’t even close? Then again how many times has a stock gone up or down when you never expected it to move like it did?
I’ve looked at a winter forecast for 6 inches of snow to drop overnight only to wake up in the morning to a clean deck and nary a drop of snow. Then again I’ve gone to bed having read online that we might get snow in a week or so only to discover our deck and yard buried with eighteen inches of snow.
How is the weather forecast similar to investing? Actually more than you might think. Let me explain.
If you get a tip from a friend on what to buy or when to sell, you should ask yourself: is this tip more reliable that the weatherman? What is the track record of the tip source?
Even if you use investment software the recommendations can be extremely accurate or not. The accuracy depends upon a number of factors:
- Does the recommendation require your interpretation?
- Is the recommendation based on one buy/sell rule or does it take into account a number of factors?
- Is the recommendation based on a back-tested strategy?
In other words if you want to manage your account with more accuracy that the weather forecast your source of information for making the recommendation needs to be proven.
Looking at just one chart may tell you a mutual fund is moving upwards but does it tell you that compared to other mutual funds it is the best of the bunch?
If your recommendation to buy or sell is based on many factors there is a greater chance it will be more accurate and less likely for you to lose when it starts to head down.
The best way to tell if a set of buy/sell rules is going to make you money is to back-test them. Consider them as a strategy or model for making your decisions.
Ideally you should take the back-test a step further and have your investment software program test all your buy/sell rules in different combinations to find the best set of rules that meet your objective. Your objectives may be based on how much money you make – the gains. But they could also be based upon how low the losses are or how frequently you need to make a trade.
The key factor is that you want your investing to be better than the weatherman. You want to develop proven strategies that are going to give you best return for your own personal goals and desires. You can do this with optimized back-testing to find the strategies you desire.