When a crystal ball is not enough to become rich

Vyacheslav Dvornikov

Oct 2, 2024

Even if investors know the news in advance, it doesn't mean they will be able to profit from it, according to a new study published on the SSRN website. The authors created a game in which trained traders were shown the front page of the Wall Street Journal (with quotes obscured) and asked how much money they would bet on the change in the S&P 500 and the value of 30-year Treasury bonds the previous day. Traders started with $50 in a virtual account and were shown 15 quasi-random covers from the past 15 years.

The results were almost comical: traders correctly guessed the direction of stocks and bonds in only 51.5% of the approximately 2,000 trades they made. In other words, this is almost equal to the probability of guessing the result of a coin toss over a large number of repetitions. Traders correctly predicted the direction of bond movements in 56% of cases, but they allocated a smaller portion of their capital to bonds than to stocks.

The average return for traders was only 3.2%, which is statistically indistinguishable from the initial capital, the authors of the experiment note. Meanwhile, high returns were shown by a small number of traders, while half lost money, and one in six went bankrupt. They were let down not only by the lack of foresight about where the markets would go but also by the decision of how much money to allocate to each bet. Even though most traders correctly predicted the direction of stock or bond movements, they did not dare to bet enough money on these trades. In losing trades, many players used excessive leverage compared to profitable trades.

Why This Matters

The study shows that in the short term, even professional traders cannot predict market reactions to information events. The authors were inspired by a 2016 tweet from Nassim Taleb: "If you tell an investor the next day's news 24 hours in advance, he will go bankrupt in less than a year." Additionally, one of the conclusions of this experiment and article is that a crystal ball is of little value without a reasonable choice of trade size.

If you suddenly think you can achieve better results, you can test the game at this link. Write in the comments what your result will be. So far, 1,500 people who played the game online have lost an average of 30%.