Some further thoughts on forecasting?

I recently posted a couple of articles about forecasting and whether there is any utility achieved from forecasting. - The first of these was posted a few weeks a ago and can be seen at this link 'Is it folly to forecast?' this was followed up by a question on my 'LinkedIn group' - 'Is forecasting a waste of time?' - which was intended to stimulate debate rather than express my opinion, and which certainly produced some interesting responses.

Before, I proceed any further I also want to refer to an article by Michel Pireu in 'Business Day' from last year where he talks about James Montier's view on forecasting - the article can be seen here. I have discussed some of Montier's views previously, I am a huge fan of Montier's work, not only does he make some excellent points and observations, his writing style is both interesting and uncomplicated, which means unlike so many books on aspects of trading and finance, you won't need matchsticks wedged into your eyelids to stop them from shutting. - One of the points about forecasting Montier makes is that "The bottom line from this whistle-stop tour of the failure of forecasting is that it would be sheer madness to base an investment process around our seriously flawed ability to divine the future."- However, there appears more utility to forecasting, then would be merely the actual prediction element, The following highlights and summarises some of the responses from people to this discussion on my 'Linkedin' group.

Firstly some very inciteful responses which I am paraphrasing from Can Esenbel:
- Forecasting can make you prone to start caring more about being right than about making money.
- Forecasts can become 'Hopecasts' or 'Wishcasts': 'The other problem with a forecast is that we will tend to integrate our inside view as an outside view'.
- Forecasts can cause us to lose sight of the context: 'We will tend to overweight recent, eloquent confirming information while ignoring or downplaying info that we don't like. We are also like to compress or expand time frames to manage our views'.

Durga G added to this that a danger with forecasts is that:
- It is how we respond to forecasts that often be the problem : Forecasts are fine but it is the certainty one attaches to a forecast that leads to trouble.

Biju Dominic made an interesting point:
- It is inherently difficult for a human beings to believe that the future is uncertain. So despite enough and more studies that show that it is impossible to predict the movements of a financial market, or the way the consumer will behave in the market place (I am sure many of us have read the book Why Most Things Fail by Paul Ormerod and Wrong, Why Experts Keep Failing us by David H. Freedman) it is imperative that 'experts' are expected to have a point of view about the future.

- Ian Copsey, a market forecaster himself, backed-up this point of Biju's with some examples of his work. Ian is the sort of person Biju was highlighting, experts in their field, who may be able to add some value to the traders/ investors own perspective.

- Some excellent counter-points were however made by Richard Brown and Mao Song-Gong. Which brought in some other aspects of forecasting: The essence of these being that despite most (not all) forecasts being nothing more than educated guesses with little chance of being accurate, they do provide a context or focal point for a trader or investor, without a forecast or belief many people are really just looking at numbers moving. Further to this, they also provide an opportunity to learn and increase our knowledge of the current market, by having a reference point to assess what we see against what we think. Thus they help us in proving clues which can help us to try and complete parts of the jigsaw: Taking this analogy a little further, when one tries to complete a jigsaw, it is often a trial and error process, which involves looking for pieces that may fit. - In the markets of course it is virtually impossible to ever complete the jigsaw, but at least one may try and put parts of it together to have a sense of the bigger picture.

I would like to add something to this, which partly builds upon the point made by Biju above. Markets are inherently uncertain places, and entering them means venturing into an uncertain world. - We need a strategy to cope with this, or we risk being paralysed by fear, and thus never taking part in seeking risk. - These strategies will depend very much on ones personality and behavioural characteristics and preferences. -Thus an inherent part of your strategic approach to trading will be an attempt to reduce your uncertainty (or ambiguity aversion). The tactics you adopt to achieve this will probably depend on your preferred behavioural approach or personality: For some it will be following rules, or taking a systematic approach; others will like to expend energy keeping very close control on themselves, their trading and their risk-management, others will limit their exposure to the market to mere seconds or minutes, - I could go on, but I am sure you get my point. - One approach to reducing uncertainty is to make (or to have) a prediction of what may happen next, whether or not it turns out that way, is not really as important in this sense, as to how it reduces uncertainty within the trader's mind.

Further to this last point, and to echo some of the above points, forecasts also provide a reference and focal point to events in the market. Some traders are able to make successful trades out of incorrect forecasts, this is because the subsequent market actions following the forecasts enables the trader to eliminate certain courses of action, and can help highlight favourable risk/reward set-ups.

In summing up, I would say that it is not folly to forecast, there is real utility to forecasting and to reading peoples forecasts, though this will largely depend on a trader/investor's working approach and style. I would however add a note of caution; traders and investors must make sure they keep forecasts in perspective, they are not and never will be a road-map of the market, in most cases they are 'best-guesses' based off limited and ever-changing variables. However they are useful noise, knowledge and information, they can help provide a focal point to the market and a context to price action and news/events. Further more they will always be needed and demanded because people need ways to reduce uncertainty, and will seek leadership and expert advice. .