Investors have to consider many things in order to be successful. Some things which are of particular interest will be the current value of any investment which they are holding as well as the expected future value of an investment. After working with so many rounds of venture capital and investments, here is my take on it:
How to predict market performance?
Even then success is not guaranteed because experienced investors will also constantly look at the history of a particular investment and how it has fluctuated over time. All of this information will then be used in order to make well-informed decisions regarding current or future investments. There are many investors who will stay away from indexes or stock which is showing sudden increases in value. Such things are treated with suspicion because it can just as suddenly decrease in value. Likewise, investments which are currently doing poorly is also avoided because there is a strong likelihood that they will continue to decrease in value. The question is how many of these assumptions are based on fact and how many are based on myth? Is there any academic evidence available to support any of the assumptions mentioned above? Every investor needs to know how the market functions and also what can be done to more accurately predict all of those frequent fluctuations and changes.
The issue of momentum
There are certain well-established market trends which has been found to be steady and reliable and which has to be respected by investors. One commonly held assumption is that it can be expected that market movements will mostly continue in the same direction. This is based upon behavioral finance. If someone was to observe investors over a period of time they will see that there are many investors who won’t keep their money in a stock that seems to be failing. Instead, they will be investing in stock which is behaving positively. These actions are mostly considered to be driven by greed and fear. A lot of research has been done in the investment markets. It has been determined that in most cases mutual fund inflows are positively linked with market yields. In this regard, momentum is playing a huge part in the decision of investors to invest. However, when large numbers of people become involved this will stimulate the market, values will increase resulting in even more people investing. This is considered to be a positive feedback loop. Research has discovered that individual stocks have momentum. In most cases when a stock or bond has been performing well for several months running then it is very likely that such a stock will continue to perform well for several more months. The opposite is also true that when stocks have been consistently performing poorly then it could be reasonably expected that that negative performances will continue.
The mean reversion principle
People who were been involved in investments over a period of time and who has experienced numerous market fluctuations have come to discover that the markets will always even out given a sufficient amount of time. This is why substantially higher market prices have been found to discourage many investors from investing. Rather it is low prices which are encouraging investors to make use of opportunities which might be encountered. Market statistics which is going back decades have clearly shown the tendency of a variable which in this case can be the price of a stock will return to a normal value at some future point and this is known as mean reversion. Many economic indicators have provided evidence of this phenomenon and this is something which is very useful for investors to know about. Other important indicators are GDP growth, unemployment, exchange rates, and interest rates. Business cycles are known to be another result of mean reversion. There is still some uncertainty regarding the issue of whether stock prices will also eventually revert to the mean. However, research has indicated mean reversion in data which has been accumulated over long periods of time. But this has not happened in all cases. However, there are many experts who feel that not enough data is available because of the absence of trustworthy long-term studies.
The Martingales principle
There are some investment specialists that are of the opinion that past returns are simply not important. In one study it has been discovered that pricing trends which were seen during the past had no effect on future prices. Apparently, when the markets are functioning efficiently past returns should not make a difference. The conclusion was that market prices are martingales. This is simply a mathematical series in which the most appropriate prediction for the next number is the current number. Probability theory makes use of this concept in order to determine the results of random motion. Suppose a person has $50 and all of that money is gambled on a coin toss, how much money will that person have after the coin has been tossed? Such a person may either lose or win and therefore they may have nothing or they may have a hundred dollars. However, according to the experts, the best expectation is $50 which was also the starting position. This is why according to the experts your expected fortune after a toss is a martingale. When it comes to things such as stock option pricing stock market returns could be assumed to be martingales. To understand this better, the evaluation of the option does not rely on the past pricing trend. Neither does it rely on the estimation of future prices. The only important factors are the current price as well as the estimated volatility.
Investors in search of value
It is well-known that investors who are seeking genuine value will always purchase stock cheaply in search of future rewards. There is the expectation that an inefficient market might have underpriced the stock and therefore it could be expected that the price will adjust if given enough time. The question is, is this a realistic expectation? Is it possible that an inefficient market can make such adjustments? Interestingly research which has been conducted indicates that mispricing, as well as readjustment, is something which is continually happening. Unfortunately, it is not known exactly why this is taking place.