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Your Wealth Journey Investment Insights – Using Group Intelligence for Buying Low and Selling High

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Welcome to the next installment in our series series Your Wealth Journey Investment Insights: Using Group Intelligence for Buying Low and Selling High.

When it comes to your wealth journey (or anything in life worth doing well) it helps to know what you’re facing. In this case, that’s “the market.” How do you achieve every investor’s dream of buying low and selling high in a crowd of highly resourceful and competitive players? The answer is to play with rather than against the crowd, by understanding how market pricing occurs.

The Market: A Working Definition

Technically, “the market” is a plural, not a singular place. There are markets for trading stocks, bonds, sectors, commodities, real estate and more, in the U.S. and around the globe. you can think of these markets as a single place, where opposing players are competing against one another to buy low and sell high. Granted, this “single place” is huge, representing an enormous crowd of participants who are individually AND collectively helping to set fair prices every day. That’s where things get interesting.

Group Intelligence: We Know More Than You and I

Before the academic evidence showed us otherwise, it was commonly assumed that the best way to make money was by outwitting others at forecasting future prices and trading accordingly.  Unfortunately for those who are still trying to operate by this outdated strategy, a simple jar of jelly beans illustrates why it’s an inherently flawed approach.

Academia has revealed that the market is subject to a number of important forces over the long run.  One of these forces is group intelligence. The term refers to the notion that, at least on questions of fact, groups are better at consistently arriving at accurate answers than even the smartest individual.

“Everybody has some information. The function of the markets is to aggregate that information, evaluate it, and get it incorporated into prices.” - Merton Miller

Take those jelly beans, for example. In one experiment, 56 students guessed how many jelly beans were in a jar that held 850 beans. The group’s guess – i.e., the average of the students’ individual guesses – came relatively close at 871. Only one student in the class did better than that. Similarly, structured experiments have been repeated under various conditions; time and again the group consensus was among the most reliable counts.

Now apply group wisdom to the market’s multitude of daily trades. Each trade may be spot on or wildly off from a “fair” price, but the aggregate average incorporates all known information contributed by the intelligent, the ignorant, the lucky and the lackluster. Thus the current prices set by the market are expected to yield the closest estimate for guiding one’s next trades. It’s not perfect mind you. But it’s assumed to represent the most reliable estimate in an imperfect world.

Put This In Your Backpack

Understanding group intelligence and how it governs efficient market pricing is a first step in more consistently buying low and selling high in free capital markets. Instead of believing that you can regularly outguess the market’s collective wisdom, Your job then becomes efficiently capturing the returns that are being delivered.

But that’s a subject for a future Your Wealth Journey Investment Insights. Next up, we’ll explore what causes prices to change. Chances are, it’s not what you think.

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(Disclaimer: Illustration based on voluntary participation at client event hosted by a financial advisor, August 2013. Results audited by advisor.)