Predicting The Next Crash

As a personal dlsclaimer I should point out that Sornett has been making predictions of crashes for over a decade and I dont believe he has gotten one correct. His last prediction of note was that the S&P500 would crash to 700 points in 2004, if memory serves me correctly that didnt happen. In their own words he admitted that More than two years have passed and our projections for the US market have not been verified. Thats academic speak for we got it completely wrong.

I understand the psychological seductiveness of prediction, it brings a perceived sense of order to a chaotic and sometimes frightening environment. I also understand the allure of believing that the market is a problem to be solved.
People are also apt to believe in the power of the expert, after all we trust many other areas of our lives to experts why shouldn’t we trust our economic future.

To get an insight into the world of prediction consider a study by Philip Tetlock who ran a 20 year study on expert prediction. He picked 284 people who made their living commenting or offering advice on political and economic trends and he asked them to assess the probability that certain events would occur, both within their area of expertise and in areas where they had no specialized knowledge. At the completion of the study in 2003 the experts had made some 82,361 predictions.

Tetlock measured his experts on two dimensions. How good they were at guessing probabilities and how accurate where they at predicting a very specific outcome.

After some particularly impressive number crunching Tetlock reached an interesting conclusion. Experts are useless at prediction. The studied experts had performed worse than if they had merely guessed about various outcomes. So experts who spent their lives and derived their income from predicting possible future outcomes in a variety of fields where no better than a lottery. He also found that they were no more reliable than non-specialists in the field who had merely guessed about a given outcome.

As we all know trading is also full of its fair share of experts whose accuracy is about impressive as that found by Tetlock in his study. I have written tens of thousands of words on prediction over the past twp decades and not once has any prediction I have ever seen made by either expert or psychic come true. As such I will leave the final words are simply this –

“An expert is a person who avoids making the small errors while sweeping on to the grand fallacy” Weinbergs Corollary