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The stock market forecast offers a long-term look at anticipated trends in the market. Around the beginning of the year, a number of ambitious forecasts are released, which attempt to explain how the market will change over the coming months. Before you make trading decisions based on the stock market forecast, it’s important to learn more about just what this is.

  • Stock market forecasts may utilize many different strategies to predict future trends.
  • Some stock market theories contradict one another, making it difficult to choose the best approach.
  • Forecasts for stock market performance are best used with a cautious eye.

What Is the Stock Market Forecast?

To properly understand a stock market forecast, you need to have a solid understanding of how the stock market works. The stock market is essentially an auction house selling shares in companies’ stocks. These shares give the shareholder partial ownership of the company which can come with perks like voting rights. The company benefits from the sale of stock as it earns capital from each share that’s purchased.

When a company sells its first shares, they’re issued through an initial public offering (IPO). After that time, investors can buy and sell shares among themselves. The exchange of these stocks demonstrates their supply and demand. Stocks that are in high demand are more expensive to purchase, while those with low demand also have a lower price.

Since prices are determined by a range of unpredictable factors like the psychological desire to own a particular stock or the potentially irrational behavior of the investor, there’s no clear science governing how stocks perform. However, there are some useful and somewhat predictable factors that impact a stock’s price. A stock market forecast analyzes things like behavioral finance, stock market trends, and historical patterns to make a knowledgeable guess about future trends.

How Are Stock Market Forecasts Determined?

There are several strategies that you can employ to evaluate the stock market forecast. The most comprehensive approach is to assess multiple factors and look for common trends.

Evaluating the stock market yourself is difficult if you’re not extremely familiar with finance and stock trading. It’s typically best to turn to experienced financial advisors and other experts for stock market predictions. However, understanding some of the information that’s used to create these forecasts will give you the opportunity to evaluate different forecasts for yourself and make an informed decision about which predictions you feel are most accurate.

Keep in mind that stock market forecasts typically take a very long view of the market. They look for trends that will play out over the course of months or years, which are difficult to evaluate. A comprehensive forecast can be very interesting, but it’s not always accurate. As you’ll see, many popular strategies for developing forecasts contradict one another, making it impossible to ensure any one prediction.

Momentum

Trending movement, or momentum, in stock market prices is a key predictor of future performance. When evaluating the momentum of the stock market, you generally assume that significant stock market movements will continue in the same direction. Thus, a stock that’s on the rise will continue to rise as others are compelled to purchase it because of its apparent success. Stocks that are falling are less likely to draw the attention of investors, therefore they continue to fall.

It’s worth noting that momentum is only an accurate indicator of short-term movement. Stocks are likely to maintain their momentum over the course of a few months, but their momentum typically changes when evaluated over the course of a few years. A stock that’s currently falling can present a good long-term investment because it’s likely to come back up over a period of three to five years. The inverse is true as well, with rising stocks seeing downward movement again over the course of several years.

Martingales

Martingales are mathematical series where the only relevant indicator for the next number is the current one. Using this approach, a forecaster would evaluate only the current stock price when estimating what the value of a particular share will be the next day. This discards any data regarding pricing trends, keeping the focus solely on the price of the day.

You might also approach the stock market forecast with a sub-martingale, which uses the same theory while adding that it’s more likely for a price to rise than to fall. Over the course of stock market history, it’s statistically more likely for prices to go up than down, so you might assess the current price, assume an increase that’s in line with the stock’s known volatility, and use this to determine the likely forecast.

Mean Reversion

The theory of mean reversion states that stock market prices will all eventually even out. Taking this view of the market, one would be more likely to invest in stocks that are currently priced low based on the assumption that these prices will rise to meet the average. High-priced stocks then become undesirable, as the long-term prediction is that they will fall to the average.

Mean reversion has proven out in other areas such as interest rates and exchange rates. It’s not yet known whether stock prices truly revert to mean rates, because this hasn’t been seen. The theory is that if mean reversion is applicable, it will only happen over an extremely long period of time. This type of forecasting doesn’t apply to short-term trends.

How to Use the Stock Market Forecast

Advisors are generally divided on whether or not investors should rely on the stock market forecast for their financial decisions. While some predictions may prove out and offer an edge with one’s trading activities, it often seems that predictions are equally likely to fail. Many experts recommend ignoring annual forecasts and ambitious new year’s predictions in favor of employing smart trading strategies that evolve daily.

Take a balanced approach to stock market forecasts by:

  • Reading multiple forecasts and looking for common threads
  • Ignoring outliers among the predictions
  • Evaluating forecasts against daily and monthly trends
  • Balancing long- and short-term strategies to minimize your risk
  • Treating forecasts as interesting guesses rather than predetermined conclusions

Pros of Using a Stock Market Forecast

While stock market forecasts aren’t always accurate, there are some benefits to reading them. Evaluating different stock market forecasts is a good way for new investors to learn more about the stock market. These forecasts often use and explain key terms like bear market and bull market. Familiarizing yourself with this lingo will help you operate more effectively and confidently in the stock market as a whole.

Reviewing stock market predictions can also give you a benchmark to evaluate trends against. With an idea of what you’re looking for in the coming year, you can better assess how different situations ultimately play out. Comparing early predictions with actual occurrences throughout the year may give you new insights into how market trends have played out.

Use the stock market forecast as an interesting tool that’s worth evaluating rather than a solid ruling on how to manage your finances, and you can gain a great deal from these reports.

Cons of Using a Stock Market Forecast

Stock market forecasts have consistently proven to have only moderate success. Director of research for The BAM Alliance, Larry Swedroe, conducts an annual analysis of year-ahead predictions from Wall Street analysts. He’s found that only 32% of predictions characterized as “sure things” actually happened. This indicates that it’s more likely for a prediction to fail than to succeed.

Forecasts aren’t always issued with the goal of making accurate predictions. Often, analysts produce forecasts to generate a stir, earn a following, or draw traffic to their sites. The more volatile and controversial a prediction, the more likely it is to draw attention. This can make inaccurate forecasts as effective as those that are proven true, depending on the forecaster’s underlying agenda.

Use stock market forecasts with extreme care. You might glean some useful information from them, but it’s unwise to base your decisions too heavily on broad predictions. If you’re interested in learning more about how the stock market works, consider signing up for an informative webinar on the topic that will help hone your trading skills.

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

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