You can see that all of our investment and trading models are based on historical analysis. You need to study history in order to become a successful investor. To be specific, at the very least you need to study stock market and economic history.
Whether or not they realize it, EVERYONE is learning from history. They’re either learning from their own history or someone else’s history.
- People learn from their own history when they make a mistake and learn not to repeat that mistake again.
- People learn from other peoples’ history when they study what others have done, and see what they should replicate/avoid. That way they can learn from others’ successes and avoid others’ failures.
If you really think about it, kids learn from history. All of humanity learns from history.
For example, why do adults know that they should be careful when handling paper? Because when they were a kid, they probably handled paper and got a paper cut. The paper cut hurt. They learned from past experience
In the stock market, you need to learn from the past. The past is what all analysis comes from. Conventional trading wisdom states that e.g. “when RSI is low, the stock market will bounce”. Whether or not that is true is besides the point. But let’s imagine we’re the people who believe this to be true (i.e. the technical traders). Where does this “analysis” come from? It comes from historical analysis.
No baby is born thinking “gee, RSI is oversold, that must be bullish for the stock market”. A baby knows nothing about RSI. Someone who first reads technical analysis will stare at a few price charts. Price charts for the S&P 500 show THE PAST. They see that “in the past, when RSI got low, the stock market bounced”. And that’s how human traders learn. They learn from history.
Likewise, no baby is brought into this world thinking “excessive levels of debt are bad for the economy”. A baby doesn’t even know what debt is. As people grow up, they hear stories about the Great Depression and the 2008 financial crisis, and how excessive debt caused such economic disasters. People learn from history.
Whether or not investors realize it, they are learning from history. The difference between successful traders and unsuccessful traders is that successful traders CONSCIOUSLY learn from history. The problem with the human brain is that we have recency bias. We remember more recent events in much more vivid detail than events in the distant past. By consciously learning from history, we are looking at ALL the historical data holistically instead of just focusing on and emphasizing the recent data.
This means that you should learn economic history, stock market history, etc and then derive patterns from this history.
Taking this one step further, we quantify those historical patterns into quantitative trading models. History doesn’t repeat itself – otherwise, the world would be stagnant. History rhymes.
Some discretionary traders don’t like using history to make analysis because “we live in unprecedented times – XYZ hasn’t happened in the past”. To them, guessing is much more fun and meaningful. “I think XYZ is bullish/bearish for the stock market, because that’s what my intuition/gut feeling tells me”.
They’re wrong. Same substance, just a different form. For example, when the internet came along, people said “we have no idea how this will impact the economy and stock market. We’ve never had the internet before.” That may be true, but the internet is just another form of “a new innovation”, which is the substance. There have been countless waves of “a new innovation” in the past, all of which merely took on different forms. The industrial revolution, electricity, cars, plastics, the internet, etc. A substance can take on many different forms, but usually results in the same thing. For example, new innovation (substance) usually results in economic growth and an equites bull market.
A more current example is how people commonly describe Quantitative Easing (QE) and Quantitative Tightening (QT) with the phrase “this has never happened before”. People say “the Federal Reserve has never done QE and QT before”. True, but QE and QT are merely forms of monetary easing and monetary tightening. The Fed has eased and tightened monetary policy many times in the past, and it has usually had similar effects on the economy and the stock market. Different forms, same substance, same result.
Generally, there are 2 groups of investors/traders who say “this time is different”
- The new investors and traders who know nothing about the stock market’s history. They only remembered a time when there was a bull market, hence they think that the stock market will always be in a bull market.
- Old timers who have a constant habit of leaning bearish. These are usually the permabears. (Remember – leaning bearish goes against statistics. The random probability of the stock market going up on any time frame > 50%). The funny thing is how they’re selective about “this time is different”. They laugh at the newbies who say “this time is different”. Yet they say the exact same thing “this time is different – QE is new, it’s evil, it’s batshit crazy, the evil Fed, this is going to blow up. etc.” They just can’t get the memo that CHANGE IS NORMAL. Different form, same substance. People who think “this hasn’t happened before” just haven’t studied enough history. For example, QE is just another form of unconventional monetary policy. Unconventional forms of monetary policy have happened before. (To learn more, read Ray Dalio’s book Big Debt Crises).
“Substance” remains the same throughout the ages. “Form” is what changes. Focus on substance.
When doing any analysis in the stock market, particularly historical analysis, it’s better to err on the side of optimism than pessimism. But at the same time, you shouldn’t be excessively optimistic or blindly pessimistic. That’s dangerous.
Why should you err on the side of optimism?
Once again, because the random probability of the stock market going up leans bullish, particularly the longer the time frame. That’s just a result of humanity. Over a long period of time, humanity improves. That doesn’t mean there won’t be a lot of big problems along the way. This just means that humanity’s long term trend supports optimism and growth.
People who say that “studying history doesn’t work” often cite the line “past performance = zero guarantee of future performance”. That’s true. But in the business of predicting the future, there is no such thing as a “guarantee”. That’s why it’s called probability. By studying history, you will have probability on your side.
For example, let’s assume that historically, when XYZ fundamentals existed, the probability of the stock market going up 6 months later is 90%. And then XYZ fundamental happens today. If you go long, there is still the probability that you will lose money 10% of the time.
But if you don’t use history as a guide, you are pretty much walking blindfolded into the future and just randomly guessing based on what your gut feeling thinks is “logical”. That’s little better than a guess.