Playing Games with Uncertain Outcomes
I think that one of the most unique struggles we face psychologically comes down to how we handle uncertainty, and how we operate in uncertain environments. To a degree, everything in life is uncertain. Tomorrows high temperature, your local grocery stores stock of toilet paper, or the next 10% move in the S&P500 are all uncertain to various degrees.
Although we may find comfort in assigning certainty to specific outcomes in our life, there is a time and a place for delusion. In some environments we may favorably operate without a full conceptualization of the probabilities, while others may be present more danger. For instance holding a certain view that tomorrow is going to be a great day is less harmful than holding the view that Uranium is in a bull market.
Environments with high degrees of uncertainty are the ones we need to focus our attention, and refine our thinking on. The market represents a beautiful illustration in uncertainty, and plays effortlessly on our inherent human weaknesses.
My observation is that the mind does not naturally perform well under a high degree of uncertainty. Psychologically it seems quite simple: not knowing the outcome is scary and taps into our fundamental fears. Fears of failure, of loss, of pain, of missing out, etc.
We tend to adopt models of thinking, opinions and beliefs that allow us to navigate our environment with as much cognitive comfort as possible. I think that for most people the craving for an understanding which provides psychological comfort is more important than the accuracy of the model itself. People would rather accept a crappy model over embracing uncertainty.
As it pertains to the market environment, its critical we develop our beliefs and expectations so they are aligned with the reality we face. The reality is that any outcome in the market is uncertain. Nobody knows for sure where Bitcoin, Gold or Tesla are going to go next. The pundits on CNBC who proclaim certainty are either lying or they don’t understand the game which they play.
I’m not saying that its impossible to profit in highly uncertain environments, quite the opposite. I understand that the behaviors of market participants create patterns which are observable in price and volume. I’m not a huge technical analysis geek who obsesses over Head and Shoulder patterns or Fib levels, but you would have to be completely blind not to see some of the patterns which occur in markets.
You can make money on the technical side the fundamental side and everything in between. What matters is your beliefs and expectations regarding the market environment. If you believe that you know what the outcome of any given position/trade/investment is, you will consequentially take too much risk, not cut your losses, leave money on the table, or many other trade errors.
The scientific method becomes useful here, lets take an objective and statistical approach to understanding what edge looks like. Whatever your edge is, it is just that: a probability.
There is plenty of information out there, your job is not to consume it all. The investor who consumes all the financial information may be more informed but does not necessarily make better decisions than the non-markets individual who buys Tesla because they like the cars.
There is a very fine line between signal and noise. Signal is that information which adds to your ability to assess probabilities, noise is everything else. If we were utilizing the scientific method to determine signal, we would look at a large sample of cases where we could fairly isolate a variable and try to determine its relation to an outcome. We might find that some pieces of information provide better guide than others, this is the ongoing process of developing an edge in the markets.
We need to keep in mind one more thing. That information itself is neutral, it is only through the perception of information that we develop theories, opinions and views. Luckily for us, the mind is malleable and we can develop on our perceptions. You may have once been afraid of the dark but I would hope that by now you understand that lack of light does not indicate any inherent danger. Similarly, we may develop on our other perceptive models which allow us to operate in uncertain environments.
It is through the perception of signal that we may learn to assign probabilities to various outcomes. We do this every day naturally without thinking, but in the market its a little more nuanced and tricky.
With an accurate understanding of signal, a keen perceptive ability and an absolute belief in the unknowable, you may be able to profitably navigate environments with high levels of uncertainty.
At the end of the day it comes down to your ability to change your mind.