Tuesday, January 18, 2011

The Statistics of Forecasting - Part II

This is the second in a mini-series regarding statistics and forecasting. Not the most exciting series ever but certainly something that all investors should understand if they want to prosper in the market today.

The second thing that I want to delve into is the reason we even follow forecasting. We as humans think that we have the ability to forecast the future. Every now and then someone guesses something completely out of the ordinary and it actually happens and they are immediately in the press, on the news and on every magazine cover. The "guesser" expounds on how he or she has found some unique model that can accurately forecast the future and that we should listen to everything he or she has to say and pay them handsomely for their advice. This happens for a time until a year or two later when their forecasts fall flat everyone smells a rat and they turn their attention to the next "guesser" of the moment.

Why would we do this? The answer is that we all crave to know what will happen next. If we knew with 100 percent accuracy what would happen then we could plan for this and change outcomes that we did not like. Well that is precisely why forecasting is impossible. Everyone has a different opinion and those that "have" try to keep the status quo while those that do "not have" try to change it. These forces are constantly at work and are constantly changing the future right before our eyes.

Think of all of the disruptive technologies that have happened just in the last decade. Then try to guess as to what new disruptive technologies will replace those that have just arrived. While fun to do it is completely futile. Even if you are correct, you have no idea that your guess will be the accepted technology or just made redundant instantly by someone else's idea in a far off land that is working just as feverishly to develop the next great widget. In addition the invention of a product can create a whole new industry as new ideas spring off the original invention and most of the time the originator of the idea never even thought of the common use for the idea at the time of the invention!

Furthermore we as humans have no control over nature. We think we do in that we are convinced that we can stop global warming by creating new cars and having a cap and trade system for emissions. Now don't get me wrong, I am all for cleaning up our air quality and keeping the environment clean, but I cannot believe that we can have any impact on something as grand as the temperature of the globe.

Beyond that who is to say that there will not be some massive earthquake or some comet from outer space or some tsunami wave. All of these are beyond our control and can affect everything that happens in the future. Can you predict that? Nostradamus tried centuries ago and we are still waiting for his premonitions to come true. Don't hold your breath and do not get overly concerned for other's forecasts as all they are at best are educated guesses.

No comments:

Post a Comment