August 19, 2015

Almost every major price move in the financial markets looks predictable after it happens. This is called “hindsight bias”, which is defined thusly at Wikipedia:

Hindsight bias, also known as the knew-it-all-along effect or creeping determinism, is the inclination, after an event has occurred, to see the event as having been predictable, despite there having been little or no objective basis for predicting it.

Almost everyone suffers from hindsight bias to some degree. Of special relevance to me, many newsletter writers and other commentators on the financial markets are afflicted by it. After the event they are quick to explain how a big price move was totally predictable, but often forget to explain why they didn’t predict it ahead of time or perhaps even predicted the opposite of what happened.

It’s important to recognise hindsight bias when it occurs in the market-related opinions/analyses/ramblings you read and when it occurs in yourself. And with regard to the latter it is important not to beat yourself up or wallow in regret when the future turns out to be different from what you expected. Regardless of how predictable an outcome appears to have been with the benefit of hindsight, you can be sure that prior to it happening there were other realistic possibilities. It’s just that these other possibilities shrank to nothingness when they didn’t happen.

The best way to deal with the fact that nothing is certain without the benefit of hindsight is to simply accept the possibility that the future will not pan-out as you expect and position yourself accordingly. In particular, don’t bet so heavily on a specific outcome that you will be financially devastated if something different happens.

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