I think the way you should think about the stock market is similar to beating the Casino in blackjack & card counting. When you know the deck is rich ins face cards make more aggressive bets, when its low in face cards be frugal. I.e. don't put lots of money into the market when its hot & put more money in when its cold. That way you statistically have a better chance on getting a good return.
You are making the classic mistake of confusing domains exhibiting a normal distribution of outcomes (casino games) with domains exhibiting an exponential distribution of outcomes (the market). This is the sort of thinking that traps people into believing "it went up a lot, therefore it has to revert to the mean and go down" or vice versa - there is no basis for such a belief in exponential domains.
That is a very astute point. I say it more as a broad model. And to the point of casino games - I speak to blackjack only which has a finite set of cards in a deck.
I would argue, broadly, that there is a finite value in the stock market we just don't know what it is (and it changes significantly) but I do agree with you that there are some very significant differences and is a potential flaw in the analogy.
Actually there is a basis for it in blackjack and how to card count. That said I'm not sure what casino's are doing these days ever since the card counting was figured out.
They use a decent size shoe of several decks and reshuffle more than just in between rounds. Furthermore, the dealer only deals from a subset of the shoe IIRC.
Certainly not in the sense of the gambler's fallacy, but you can be sure that someone's fortunes from playing casino games will exhibit mean reversion in the sense that the next game is always more likely to bring their cumulative winnings closer to the house edge rather than further from it. Not so with the stock market. The stuff about card counting is basically impossible to do these days but can alter the house edge, and also doesn't apply to the market.
> I.e. don't put lots of money into the market when its hot & put more money in when its cold. That way you statistically have a better chance on getting a good return
With the caveat, historical returns do not predicate future returns. If you invested in the S&P 500 from 97-99 and didn't sell before the large sell off of 2000 you would have to wait until 2010 before you saw positive inflation adjusted returns.
Could you define what metrics you would use to see if the market is "hot" or "cold"? Could you let us know what each of those metrics would change in terms of contributions?
It's easy to say "hot and cold", but those things aren't easily definable, but it would be easy enough to backtest any theory you have. I'm pretty skeptical it's going to be valuable without getting into PhD level math coupled with an experts understanding of global politics and trade.
How do you know any of that though? Nobody really does. The fancy hedge funds and the skittish retail investor are all just guessing. Buy and hold seems to be the only sane strategy.
It is like driving down the street by looking out the back window. You are confident there isn't a dump truck parked in the middle of the street, because you didn't see one in the last 3 blocks.
I don't know, clearly - no one knows. I do know that investing in equity during the hot years is not a winning strategy at any point in time, unless you sell before it goes cool. At least from an index based fund perspective. If you stock pick (i.e. Amazon at peak 99 prices you would still have performed exceptionally well)
The stock markets are cyclical - it's tough to see how we can continue to buy into a market that is considered overbought by many financial talking heads. Once returns materialize elsewhere + cap gains tax changes materialize I expect froth will come out of markets...
