The idea of
Heads you win, tails you win
It’s all about getting probabilities tipped in your favour. Think about a game of heads or tails. The chance of landing either is 50/50. What about the sharemarket?
A study by Roeichensten and Dorsett over the S&P 500 from 1926 to 1993 showed that uncertainty about returns was smaller in the longer-term compared with the short-term. It seems that in the short-term the market is more akin to a casino but in the long-term the odds are stacked in an investor’s favour.
Which reminds me of a famous quote by Warren Buffett: “In the short run, the market is a voting machine; in the long run, it’s a weighing machine.”
Outliers and black swans
A story on
Outliers in sharetrading are often now called ‘black swans’. This reference comes from the 2007 book titled ‘The Black Swan’ by Lebanese scholar Nassim Nicholas Taleb. In the old world, swans were thought to only be white. It was only in 1697 when black swans were discovered by a Dutch expedition that people realised swans were not only white.
In the same way, there are events which may seem outside the realm of probability. When they occur, they have a major impact and after the event it is rationalised by the market.
The point is that these black swans are more common than is perceived and by forming a plan to deal with these black swans, investors can deal with these events more successfully.
Deviate from the norm
Peter Bernstein in his book ‘Against the Gods: the Remarkable Story of
Indeed it seems as though successful investors have capitalised from moving against the crowd. Whether you look at Warren Buffett or Benjamin Graham, the sharemarket seems to be an illogical beast in which business-minded people have identified great opportunities that arise from these deviations from normal.
It’s about your behaviour
“Fear or harm ought to be proportional not merely to the gravity of the harm, but also to the probability of the event” (logic believed to have been written by Antoine Arnauld).
But try telling that to a swimmer with a fear of sharks on a day after a shark attack has occurred. Or to a person that is scared to fly!
We are shaped by our individual fears and so