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Fooled By Randomness

Part 4: What to Do With This Understanding

Now that you have a fuller understanding of how and why randomness has such an outsized effect on success, and how and why people generally misunderstand its effects, let’s explore how you can approach risk with these concepts in mind. We’ll examine characteristics of people who fail to anticipate risk properly and we’ll discuss specific things you can do to anticipate risk mindfully.

How Our Misguided Beliefs Lead to Failure

Traders—and others in fields affected greatly by randomness, such as economics or politics—often have the same set of qualities that lead them to misevaluate risk and make poor decisions:

They are overconfident in their beliefs: They don’t see that what worked for them in the past may have worked because of coincidence. They don’t see that analysis of past events obscures the random element of it. Traders who blow up typically think that they were such experts that the risk of failure was non-existent. When traders take risks under such a misbelief, it’s ignorance, not courage, that drives them.
They don’t think ahead: They don’t plan for their strategy to fail and they act emotionally to pressure. If the market falls, they may start buying more stocks simply because they panic, not because of a predetermined strategy.
They don’t stay the course, or they stay too long: Sometimes traders vacillate between short-term and long-term strategies because they react emotionally to noise they should ignore. Other times they stubbornly ignore noise that has turned into meaning, choosing to ride out a sinking market instead of cutting their losses.
They think too simply: Trained to boil arguments down to their most simplistic forms, they are unprepared for the greater complexity that governs the randomness and probabilities of the market. Simplicity works for many business matters like the logistics of bringing a product to market, but it does not work for matters that have more mathematical complexity and cannot be simplified.

How to Avoid Failure in a Random World

To avoid developing the misguided beliefs above and thus avoid failure, remember that success built on hard work and smart choices is more lasting than that built on luck. Therefore, try to avoid accumulating success that relies on luck. Be aware of the ways your instincts and emotions blind you to the roulette wheel. Prepare for risks and don’t expose yourself to losses you wouldn’t be able to handle. Some specific thoughts on how to develop this mindset follow.

Anticipate Your Emotional Reactions

It is hard to act rationally when we have irrational biases driving us, even when we know better. We often know how we’re supposed to act, but we act impulsively anyway. The problem is not lack of knowledge, it’s poor execution.

As humans, we are pre-programmed to react emotionally to stimuli. The best—and often only—way to prevent our emotions from clouding our judgment is to eliminate the triggers that activate them. For example, if you can’t control your cravings for chocolate, your best strategy would be to simply not keep it in your desk. In the same way, limit your exposure to market triggers.

To prevent unnecessary emotional reactions to noise, limit your exposure to the daily barrage of information available to you: Don’t read the market reports, don’t watch television, and don’t scroll through online finance analyses. Insulate yourself from small shifts that might grab you emotionally and cause you to make rash moves.