Investing is Hard: Even if You Know the Future

What if you had access to tomorrow's Wall Street Journal today? What if you knew the inflation data a day before everyone else? What if you knew how many people lost their jobs in the US a day early? I think most of us would think we could get rich. Let me end your delusions. Investing is hard.

A recent paper by Victor Haghani and James White of Elm Partners describes an experiment called "The Crystal Ball Challenge," where 118 young finance professionals were given $50 and allowed to trade S&P 500 index and 30-year US Treasury bonds using information from the next day's Wall Street Journal front page, but with market data blacked out. The experiment covered 15 trading days from 2008-2022.

Despite having advance news, participants performed poorly overall, with an average gain of just 3.2%. The underwhelming results were attributed to participants' inability to consistently predict market directions (only 51.5% accuracy) and poor trade sizing, with many using excessive leverage. The study did find that experienced traders performed better, highlighting the importance of market experience and disciplined trade sizing. Still, even their results were only decent, considering the advantages they were given.  

What is going on? A few takeaways:

1. Professional investors better understand risk and reward, know how to size bets, how to use leverage, and evaluate the impact of news on stocks and bonds. Investing is hard and requires skill to be successful.
2. To make money based on current news events, you need to predict the news event and the market reaction. The latter depends on how much the news is already factored into markets. And this is very difficult to judge as the study showed.
3. Investment markets do a good job of predicting the future. Stocks and bonds prices , in most cases, already reflect the current news. Thus, the news doesn't create predictable movements in investment prices. This may be surprising to some, but it is a characteristic of "efficient" markets, which is a topic for another blog.

One final question. Will stocks move up or down if Trump or Harris wins? The study tells us that we would likely not make money trading stocks and bonds even if we were sure of the outcome. Play the game and see how you do.

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