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Friday, July 22, 2016

Are the movements of a stock market index predictable?

That may sound like a strange question coming from some one who regularly writes about the movements of Sensex, Nifty, S&P 500, FTSE 100. Nevertheless, it is a pertinent question.

Many small investors spend an inordinate amount of time and energy in trying to figure out in which direction a stock market index is going to move next. Some do it out of curiosity. Others, because they have taken a position in the F&O market. Some are trying to 'time the market' by fine tuning their entry or exit.

Those who have spent a long enough time in stock investing - whether using fundamental analysis, or technical analysis, or both - already know that predicting index (or stock price) movements is like tossing a coin. You only have a 50% chance of success at best.

(That may be good enough to make money. However, the 50% success rate comes from averaging multiple tosses/predictions. You may get 7 'heads' in a row and feel that you have mastered the art of coin tossing/predicting. But then you may get 12 'tails' in a row that will wipe out all your investments!)

What should a small investor do? Whether you are an inexperienced or an experienced investor, you need to accept the fact that index movements can not be predicted or controlled.

So, concentrate your time and energy on stuff that can be predicted and controlled. Like, how much you are likely to earn over the next 5-10-15 years. How much you need to save each year to achieve your financial goals. What kind of assets you should invest your savings in to get the required rate of return.

In other words, make an investment plan and then stick to that plan regardless of index movements. The plan may need to be tweaked to optimise returns - but such tweaking should not be done more than once or twice in a year.

It takes a lot of mental strength, faith and discipline to stick to a plan when an index goes through its periodic turmoil. Specially when a 15 months long bear phase decimates your stock portfolio.

But over the long term, a planned investment strategy will generate better returns than an unplanned strategy based on predicting index movements.

That was the long answer. The short answer is: Not really.  

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