“Clearly my way of
judging matters is probalistic in nature; it relies on the notion of what could
have probably happened….
If
we have heard of {histories greatest generals and inventors}, it is simply
because they took considerable risks, along with thousands of others, and
happened to win. They were
intelligent, courageous, noble (at times), had the highest possible obtainable culture
of their day – but so did thousands of others who live in the musty footnotes
of history.” (Taleb, Fooled by
Randomness).
Julius Caesar was a fantastic general, yet was amazingly
lucky (until he was not), whereas Erwin Rommel, also a fantastic general was
plagued by bad luck on multiple occasions, (with a random and erratic Commander
in Chief not helping).
What other outcomes for these generals could have
happened? And, would they be
judged by history differently for their decisions, despite no change in their
skills?
“Every once in a
while, someone makes a risky bet on an improbable or uncertain outcome and ends
up looking like a genius,” (Marks, The Most Important Thing), … or a fool.
But how do I picture these alternative histories that could
have occurred but did not?
(I saw this graph somewhere but couldn’t re-find it, so
recreated it below).
At point X now, current conditions are known (as best as
available information can be utilized).
The correct decision (always) to take is the one that is logical, intelligent,
and informed “at that time” (Marks).
At point X now, all red outcomes are “possible” and unknown,
but some are more “probable” than others.
At point Y later, only a single red outcome has eventuated. At which point it often becomes
hard to imagine that any of the others were “possible” to begin with.
(Note: The distribution in reality may be skewed towards one
side of possible outcomes. This is
more to highlight the concept of possible and probable only, not the
mathematics).
When things go as predicted (luck playing a role), people
tend to look like geniuses for their correct actions. “Coincidences look
like causality. A lucky idiot
looks like a skilled investor.” (Marks). However, the correctness or quality of a decision
cannot be judged by its outcome, especially if randomness is involved. For this reason correct decisions based
on a sound process are often wrong, and the macro events that may have caused
it, beyond anticipating. Incorrect
decisions and processes can also be seen
as correct, with an unanticipated event causing the outcome you wanted.
Whilst the mean is the most “probable” outcome (reversion to
the mean?), it is not at all certain, as for any individual situation, all
outcomes are “possible”. In fact
the collective likelihood of all the other outcomes is higher than the one we
think is most probable!
The most extreme outliers at +3s and - 3s can be the black swans (good and
bad). (Maybe there should be black swans AND white knights?).
At least by having a good process at X, we can limit the
pain of black swan events and not necessarily experience account destruction
when they do occur. We must trade
based on what we think are probable outcomes, while not doing too much damage
or loss in the rest that occur.
We need to cut off the bad tails effect on us, or limit it. Fortunately options do that, yet expose
us to the full range of favorable possibilities.
This does not mean to imply not trading a contrarian
strategy, or positioning to get lucky etc. Its what we think are probable and possible, based on our
analysis, not probable as in the herd thinks it likely.
I think understanding that we can’t know the outcome of all
that is possible, but can try to understand what is probable and position
accordingly, whilst protecting the risk of severe damage to my account, is the
best thing I have learnt in 2014.
(Possibly! Probably!)
Clearly some “alternative histories” would have been far
worse than the one we know. But in
1940, our now known outcome was
nowhere near certain, and one could argue improbable. The things that HAVE happened in the world are just a “small subset of the things that COULD have
happened.” And finally, “ensure survival” (Marks).
(If you want to think more about alternative histories, watch
the Back to the Future movies!)
