4. Belief that you can predict the market
It is wise to understand the fundamentals of your investments and to even build financial models, but don’t fall into the trap of thinking you can predict the market. Even the best investors get it wrong.
The problem is that the market is very complex with huge numbers of variables to take into account. On top of a stock’s fundamentals, there are the actions of management and competitors, the biases of traders, and the underlying economic and financial conditions, among other factors.
Then there is noise. There is so much information available and so much price volatility that it is hard to find statistical relationships between price movements and other variables. Investments have a low-signal-to-noise ratio, which makes accurate prediction difficult.
However, the solution is not to throw out your models and fundamental analyses but to use them with humility. Use them as a guide rather than as gospel.
“The daily blips of the market are, in fact, noise – noise that is very difficult for most investors to tune out.” — Seth Klarman