There are two prices that are critical for any investor to know: the current price of the investment he or she owns, or plans to own and its future selling price. Despite this, investors are constantly reviewing past pricing history and using it to influence their future investment decisions. Some investors won’t buy a stock or index that has risen too sharply, because they assume it’s due for a correction, while other investors avoid a falling stock because they fear it will continue to deteriorate.
Does academic evidence support these types of predictions, based on recent pricing? In this article, we’ll look at four different views of the market and learn more about the associated academic research that supports each view. The conclusions will help you better understand how the market functions and perhaps eliminate some of your own biases.
4 Ways To Predict Market Performance
“Don’t fight the tape.” This widely quoted piece of stock market wisdom warns investors not to get in the way of market trends. The assumption is that the best bet about market movements is that they will continue in the same direction. This concept has is roots in behavioral finance. With so many stocks to choose from, why would investors keep their money in a stock that’s falling, as opposed to one that’s climbing? It’s classic fear and greed.
Studies have found that mutual fund inflows are positively correlated with market returns. Momentum plays a part in the decision to invest and when more people invest, the market goes up, encouraging even more people to buy. It’s a positive feedback loop.