How often has it been for us to be in situations when we told ourselves that a particular scenario could be entirely avoided due to the so-called obvious facts that are laid in front of us?
You got drenched while walking to the bus stop. The clouds seem dark just now, you think to yourself. In hindsight, you should have bought an umbrella.
Your favourite team just lost the championships by letting in a goal in the last 5 minutes. They seem weak on their defence, you think to yourself. In hindsight, they should have focused more on their defence.
These are just some common thoughts that we often have in our daily lives.
Just like weather and sports, the financial market is also one area where there will always be an unpredictable element.
The stock you just bought crashed. The market is obviously still on a downtrend, you think to yourself. In hindsight, you should have waited a while longer before buying.
I'm sure almost every one of us runs into this situation when we are investing.
This is what we called the hindsight bias.
Hindsight bias represents the common tendency that we have in believing that we should have been able to predict a certain outcome based on past events. The investors in the late 1990s should have obviously seen the huge bubble in technology stocks and avoid it. The investors in 2007 should have known that the subprime crisis is bound to happen with the large amount of high risk mortgages. You get the drift.
It's always very easy to put on the hindsight lens and think that everything should be as plain as day. Obviously, it isn't. If it is, you won't have the market crashing in all of those previous crises.
This is also exactly what's happening now. The market has been on a downward trend the whole of 2022. S&P 500 is having a return of -14% YTD. There are many who claim that the super run-up in the market from the end of 2020 to 2021 is already a very good indicator that the market is very likely to drop in 2022 and we should all easily avoid this downturn.
Again, it's obvious to see it this way now. But I challenge everyone who has this thought to think about this. How do you think the market will behave in the next few months?
In March this year, the market was trending downwards until a technical rebound happened in the second half of the month. During that time, I did this poll in my Telegram channel.
After 24 votes, we arrive at a perfect standstill. Half of the respondents think that the technical rebound represents the market resuming its uptrend. Half of the respondents think otherwise. Despite a total of 24 votes, we are no better than doing a coin toss.
In hindsight, it's easy to say that the market is obviously going to continue to trend downwards from what we observed in April and May. But again, it's never as easy as it seems.
During bear markets, it's very often to have multiple short term rallies of more than 10%. In this article from businessinsider, it's highlighted that 17 out of 26 bear markets since 1929 have seen short term rallies of more than 10% with an average count of 1.5 fake rallies per bear market.
Could you imagine how difficult it is to determine if the market has bottomed in these scenarios? How do you tell a fake rally from a real rally? I don't think any of us can do so.
It probably also doesn't help that volatilities are especially high during bear markets.
During bear markets, VIX has always been especially high. This represents very big swings in the market in both directions. With such high volatilities, emotions often come into place. You might get very excited when your portfolio starts showing some signs of green but only to be disappointed when the market starts to trend downwards again in the next trading day. When you get emotional about it, you tend to make irrational decisions about your investing portfolio and that often results in regrets.
Very often, successful investing is never a one straight line. You have to be prepared for swings in the market and understand that staying on course is important.
In any given year in the market, you will see an average of -15.8% for the maximum intrayear drawdown in S&P 500. Can you imagine running away from the market because of this seemingly big drawdown? You will have missed out on a lot of the gains along the way.
Hence, forget about seeing things in hindsight.
You will never see it coming. Learn to dance in the rain.
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