When I hear people discussing investing, they usually make predictions. Some people plan to act on their convictions. Unfortunately, many investors don’t understand that even if they are right they may not make money. Some predictions, if correct, can lead to profit, but not others.
For example, investor Bill believes RIM’s technology is inferior to that of its competitors and he sells RIM stock short. Even if he is right about RIM technology, he may not make money. The problem here is that this prediction about the future success of RIM’s technology in the marketplace may already be built into RIM’s stock price.
The important question is whether RIM’s troubles are bigger or smaller than the market believes. If another investor, Jane, is correct in her belief that while RIM has some technology difficulties, the market’s concerns are overblown, then she can make money by buying RIM stock. Both Jane and Bill may be right, but Jane will make money and Bill will lose money. All predictions have to be measured against the market sentiment that is already built into equity prices.
Another good example is interest rates. If you believe that short-term interest rates are going to rise, should you take a 5-year term on your mortgage? Current long-term rates already have expectations about changes in short-term rates built into them. If short-term rates rise, but by less than the market expected, long-term rates may drop making your 5-year mortgage term look like a bad idea.
For information about the future to be profitable, it has to be information that other people don’t have. Whenever you plan to commit money to a conviction you should ask yourself “what do I know that others don’t know?”