The stock market can be completely unpredictable because it relies on a series of factors that influence how investors act. So why is the stock market unpredictable?
In this article, we will go over the main reasons why the stock market is so unpredictable, and how investors can deal with the constant volatility and risk.
Is the stock market unpredictable?
According to the Random Walk theory proposed by Burton Malkiel, who advocated that the price of stocks fluctuates based on random events that show no correlation between each other. While some individuals are able to predict how the broader market will behave in a short timeframe, it is completely impossible to accurately predict every stock market movement.
Why is the stock market unpredictable?
There are several factors that influence the volatility in the stock market, and that makes it so difficult to predict. To start the main reason is that stock prices are settled based on the emotions, and investment decisions of millions of people around the globe.
All of these investors are either bullish or bearish on a specific stock or industry, and this makes them buy or sell a specific security. With all of these opposing views, it means that over time, they might swing to the bull side or bearish side quite frequently.
Beyond this well-known fact, there are also other reasons that influence how stock prices move, and that makes it so difficult to predict what the market will do exactly.
Factors that make the stock market unpredictable
Here are the main factors that make the stock market unpredictable:
News and events
Every day there are thousands of news that come up, either positive or negative. This news affects not only the broader economy but also how one particular stock price moves.
There are macro news and events, which affect the global economy, regions of the world, and also different industries. Any positive or negative development at a macroeconomic level could have enough impact to push a stock price either down or up.
Then we have different specific news related to companies that can also affect how the marker perceives that particular stock. Earnings reports, short reports, analyst recommendations, or even news about the company can have the potential to influence the stock price.
There are two main emotions that make the stock market unpredictable: fear and greed. While some investors are eagerly excited to invest in stocks, some are fearful. These emotions change every day as stock prices fluctuate.
Greed settles in when the broader market is reaching new highs, and fear typically arises when the stock market starts to plunge.
Fear and greed are such important drivers of stock market prices, that there is a fear and greed index, which tries to calculate how investors' emotions.
Although it is common to evaluate fear and greed for the broader market, the same can happen within a specific country or region of the world, as well as certain industries and individual stocks.
When a company releases its financial results, stocks tend to move as a reflection of those same results. Additionally, companies will often release their own estimates as to how the business will perform in the coming months.
If the earnings are positive and the estimates are bright, stocks tend to reflect that by going up in price. The opposite happens when the earnings are poor, and the outlook is negative.
Expectations are one of the most important drivers of the stock market and stock prices. Every investor and trader is making decisions based on personal expectations about something.
Whether you are investing in stocks to hold for 20 years, or you want to day trade, expectations about the future either in the short-term or long-term drive investors’ decisions.
Ultimately these expectations also affect how stock prices move, and they are one of the key factors to understanding why the stock market is so unpredictable.
Economic indicators also have an impact on how the stock market performs, after all the market reflects how the companies within the economy are doing.
Since economic indicators can have such a direct impact on how companies perform operationally and financially, it has the ability to directly influence stock prices.
Every investor perceives these factors differently
All of these factors combined help to understand why the stock market is so unpredictable. All of these factors can also have a different impact on investors. While some news or event can lead one investor to buy a stock, and another to sell.
What the stock market does is that it finds the consensus in price that investors are willing to pay for certain assets, based on supply and demand.
Is the stock market very predictable?
No, the stock market is extremely difficult to predict with a certain level of accuracy. It is nearly impossible to predict how the broader market or a specific stock or asset will fluctuate in the price for a long time.
This does not mean that certain traders do not try to make these predictions, and in fact, some of the most successful traders can be right most of the time. However, they are not right all of the time, as it is impossible to always predict what the market will do.
Why is the stock market so erratic?
The stock market is so erratic because it reflects how millions of individuals are expecting it to perform. These expectations are driven by personal reasons, as well as other factors that ultimately affect how the market can behave.
Is the stock market actually random?
Although there are some conflicting theories as to whether the market is random or not, it is usually accepted that stock markets are completely random. There are thousands or millions of different events happening every single day that drive stock prices up or down.
These events show no correlation between each other, and they are completely random in nature, at least in the short term. Over time, stock prices tend to reflect how the underlying business is performing both at an operational and financial level.
Earnings are the main driver of stock prices in the long run.
Volatility will always be present in the markets, and it is one of the reasons the efficient market hypothesis continues to be questioned both in the markets and at an academic level. While some investors might fear volatility and their stock prices fluctuating can make them sell in panic, they should actually embrace it.
The fact that the stock market is so unpredictable is what allows investors to buy equities at discounted levels, and sell them when they are overvalued. Volatility in the price of stocks is also essential for traders to make a profit, and without it, there would be no trading.