Written by: Jared Coffin
I remember years ago when I first decided to trade stocks. I looked at a few charts and thought: How hard can this possibly be? I will buy stocks when they're going up, and sell - or short sell - stocks that are going down. I was already mentally purchasing my millionaire lifestyle. It's quite comical when I think back on it. Boy, was I naive! Yet, unfortunately, this is how many people tend to think.There were so many factors I wasn't considering. First, I was looking at charts from a hindsight perspective. Of course, everything looks easy in hindsight. Second, I didn't factor in human emotion. This was a big one. Seeing negative or positive numbers flash across your computer screen can affect your decisions. It might bring on unnecessary anxiety or cause you to panic. Third, there are so many unknowns and variables. Such as: Is the company going to exceed projected earnings? Is the company being sued? Has Warren Buffett acquired a large stake? Did a drug trial fail? Is it an algorithmically traded stock? Is the economic data going to be good or bad? And on and on. I could come up with an endless number of possibilities that on any given day might affect an individual stock or the market in general.I don't think people realize how hard it is to predict the movements of the market and how much brain power must be expended daily just to survive in this game. In a previous blog, Data Over Emotion, I discussed how the direction of stock prices can cause us to become biased, overly excited, or fearful.When a chart is looked at in hindsight, it makes us believe things are easier than they truly are. I know in the beginning I fell victim to this bias. I was looking at charts, marking where I would have bought and where I would have sold. However, could that have been done in real time? Possibly. But probably not.Let's look at a few sections from the historical charts of the S&P 500 and see if we would have been able to tell the future direction based on price alone, as we see it within a given time frame. The reason I'm using the S&P 500 instead of an individual stock is that I can't count the number of times I've heard people get excited based on financial news reports such as: "The Dow Crossed 26,000 Today!" or "The S&P 500 is at an All-Time-High!" It gets people excited and makes them want to buy. But does that mean the market will continue to rise? And the same goes for downward trends.I've removed the dates and all labels from the first chart in both sections below. I merely want you to see the direction the price has headed within a given time frame. Do you think the market will subsequently go up, down or sideways?Remember, we're trying to remove hindsight bias and look at it through the lens of how we would have seen it at that time. Example #1


