Would you rather invest with a financial expert or an investment manager that harnesses the collective wisdom of market participants? Many investors think successful money managers must possess a better crystal ball or have expert knowledge that others do not possess. However, time and again the markets demonstrate that experts are poor at predicting the future.
James Surowiecki’s “The Wisdom of Crowds” is an excellent book on this subject. In the introduction, Surowiecki tells the story of a weight judging competition at the annual West of England Fat Stock and Poultry Exhibition in 1906. Participants purchased 800 tickets attempting to correctly guess the weight of a large ox after it was to be slaughtered and dressed. Prizes were awarded to those who guessed the closest. Among the attendees of the exhibition were butchers and farmers, some highly skilled at estimating the weight of cattle, yet most had no specific knowledge of the challenge at hand. Also in attendance was Francis Galton, a mathematician and statistician. Galton decided to conduct an experiment and requested the tickets which recorded the participants name, address and weight guess following the competition. He figured the guesses would be far off the mark and expected to plot a bell curve out of the data. Of the 800 guesses, 13 had to be thrown out as they were illegible. With 787 tickets, Galton summed the guesses and calculated the average weight which worked out to 1,197 lbs. Incredibly, the weight of the ox after it had been slaughtered and dressed was 1,198 lbs. The sum guess of all participants was vastly more accurate than any individual participant’s sole judgement.
Investors take comfort in investing with an expert. What is under appreciated, however, is the collective knowledge of market participants. The closing price of a financial instrument represents the sum knowledge of all participants at that moment in time. Those who feel the asset is undervalued purchased it and those who felt the investment unattractive have sold. The balance of supply and demand aligns at the closing price of the day. Rather than attempt to predict the future of where the market is headed, one can build processes to harness the collective intelligence of capital market participants and go with the direction of the trend. In the current market environment, we regularly hear the adage “don’t fight the Fed”, perhaps “don’t fight the collective wisdom of the market” fits better.