The Price Forecasting Illusion

There have been many times when I looked at a stock and noticed that the price was reaching a support level. On several of those occasions, I wanted to buy the stock but was afraid the support level would not hold and the price would continue to deteriorate. This happened with MOS, BP, NOK, VLO, ZQK and several others. In only one instance, with BP, the price did not hold at the support level and the price continued to decline another 20%.

A similar situation, but in reverse, has happened as well: I looked at a stock and saw that the price was reaching a resistance level, and I told myself not to buy it, but went ahead with the purchase because I expected the stock to break out of its resistance zone. Shortly after making my purchase, I watched the stock retreat from my purchase price, as though it hit a ceiling and could not go any higher, and proceeded to reverse its upward trend.

Why is it that instead of doing the first - buying at support, I do the second - buying at resistance? My explanation is price forecasting illusion. When a stock declines and comes into a resistance level, the mind focuses on the price down trend and projects further decreases as opposed to focusing on the probability that the price slide will cease. The illusion is created that the stock is being sinked by an invisible force and nothing can hold it up. The illusion of a lower price is created and the mind ceases on this and blocks it self from any action. It must be a survival mechanism of sort. After all, why buy the stock if it will continue to decline and go to zero because of the momentum it carries?

The opposite is also true. The mind anticipates the continued price increase, although the price is entering a resistance area. All stocks that continue their climb have to clear this resistance area, but very few do, or only do so after several attempts. Instead of focusing on the probability that the stock price will stall and reverse, the mind fixates on the recent price increase and expects the force which lifted the price to its current level to boost the price higher.

There has to be a way to disassociate the mind from the price forecasting illusion and help it focus on the potential price reversal. Perhaps the disassociation can be achieved by rephrasing the down or up price movement. To dissuade the mind from focusing on the price forecasting illusion, each day one should ask, "What is the probability that the stock will be higher than where it is today given where it has been in the past?". Then compare this self assessed probability, which is either decreasing, stable, increasing, with the actual price action of the following day. When the actual price action and the self computed probability are in sync then that is the time to act.

In other words, when the price enters a resistance area, after a protracted decline, wait for the area to prove itself out. The logic should flow as follows: If the price will reverse, then the probability of the price being higher is increasing with each subsequent price decline. If the price is higher on the next day, then buy near the support area price. Likewise, if the probability of the price being higher is decreasing with each consecutive price increase, and the next day the price is lower, then sell an existing position or short near the resistance area price.

The purpose of phrasing this way the movement of a stock price, is to train the mind to treat an increase or decrease in price in the same manner. The mind will focus on a positive thought (what is the probability of a price increase) and assign a strength factor to this thought (decreasing, stable, increasing)

Hence, instead of asking whether the S&P 500 is going to be down or up, I would ask, "Is the probability of a higher S&P 500 index decreasing, stable, or increasing?" By phrasing the price movement this way, I am training the mind to focus only on the strength of a one event, as opposed to forcing the mind to consider whether a down trend or up trend will be reversed.