The Stock Market Is a Terrible Place to Look for Certainty

Chicago Board of Trade Building. The building is a skyscraper and is currently the primary trading venue for the derivatives exchange.

One of my hobbies is reading academic finance papers.

I know I should likely socialise more, but most of my friends are occupied with their children.

This week, I came across a fascinating paper analysing more than twenty years of S&P 500 data. Instead of asking the usual question, "Did the market go up or down?", the author Francesco Valenti asked something much smarter:

"How did the market behave during the day?" 

It turns out that the answer matters.

Here is the link in case you are curious, financial foxes:

https://www.linkedin.com/posts/francesco-valenti-84023413_intradaypriceasymmetryandnext-dayintradayreturns-ugcPost-7424362964272549888-c8NE/?utm_source=share&utm_medium=member_desktop&rcm=ACoAAAODVpsBmetepAIT9t7Zh8g6RDME1zf-72I

Markets Are Made of People... and People Are Predictable

When markets fall sharply, investors panic.

When markets rally, investors become convinced they've discovered the secret to wealth.

Neither feeling lasts very long.

The research found that fear-dominated days are often followed by stronger trading sessions, while optimism-dominated days tend to lose momentum the next day.

No, this isn't a magic formula.

If investing were that easy, we'd all be writing this article from a yacht. Mine would probably still need antifouling.

What it does remind us is something much more important:

Markets often overreact.

Here's Why This Matters

Most beginner investors spend their time trying to predict the market.

Professional investors spend much more time trying to control themselves.

That's a huge difference.

Because your biggest enemy isn't inflation.

It isn't interest rates.

It isn't even the latest geopolitical crisis.

It's the little voice in your head that says:

"Sell everything!"

...usually the day before the market recovers.

Or:

"This stock can only go up!"

...usually the day before reality returns.

So What's the Lesson?

Don't build your portfolio around emotions.

Build it around a plan.

Diversify globally.

Invest consistently.

Accept that markets will occasionally behave irrationally.

And when everyone around you is convinced they know exactly what will happen next...

Remember that the market has a wonderful habit of embarrassing as many people as possible. Including professionals. Especially professionals.

Good investing isn't about predicting tomorrow.

It's about making decisions today that you'll still be proud of ten years from now.

Inspired by the working paper "Intraday Price Asymmetry and Next-Day Intraday Returns in the S&P 500", based on more than two decades of market data. The paper is descriptive research and is not intended as a ready-made trading strategy.