Numerology is an esoteric and mystical study of the perceived relationships between numbers and events.
Numerologists believe that you can predict market action to a fairly reasonable degree of accuracy by following their methods; however, the vast majority of us would rather adopt a slightly more tangible and credible strategy in our trades.
There are countless websites providing investment advice based on superstitious beliefs such as numerology and astrology, but you will almost certainly be better off avoiding these recommendations if you value the integrity of your portfolio.
Warren Buffett himself says that you can “torture the data until it eventually confesses,” but these self-proclaimed market experts really don’t have anything to tell you about what a given stock or currency pair is going to do in either the short term or long term.
An early-2012 feature on CNBC examined the way that the S&P 500 closed the previous year at almost exactly the same point that it opened at, with a meagre return of just over 2%.
The host of this feature mentioned that in previous years when the market had been flat the next year would be a highly lucrative one for traders. This show featured a guest who claimed to be an investment guru, confirming this perceived pattern and subtly suggesting that 2012 would be a good year.
This is a great example of how so-called gurus really don’t know what they’re talking about when it comes to investment advice.
A flat year for this index would be classed as total returns falling between -3% and +3%, and looking back at the historical data we can see that since 1961 this has only happened once, in 1994.
In 1994 the S&P 500 closed with returns of 1.3%, only to come back to a 37.6% return in 1995. In fact, the index has only fallen within this range of returns five times since its inception in 1926.
In the years that the index has fallen within this range, the following year has seen an average return of 31%. While it may be tempting to believe that there is a strong pattern here it is important to consider the fact that the sample size is exactly five, and this is far, far too small to base any conclusions on.
It is an interesting human characteristic to find perceived patterns when there are none, and as MIT finance professor Andrew Lo says, “Given enough time, enough attempts, and enough imagination, almost any pattern can be teased out of any data set.”
We couldn’t agree with this more, and it wonderfully echoes Warren Buffett’s sentiments on the subject.
If you are going to base a trading strategy around historical data then you must absolutely make sure that you are aware of any potential cognitive bias that you may be falling prey to. Also consider using a sample size that is at least a little bigger than five might be a good idea!
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