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May 21 - May 21, 2021
Western businesspeople involved in what became Russia discovered an annoying (or entertaining) fact about the legal system: It had conflicting and contradictory laws. It just depended on which chapter you looked up.
but the confusion led to situations where someone had to violate a law to comply with another.
This spaghetti legal system came from the piecewise development of the rules: You add a law here and there and the situation is too complicated as there is no central system that is consulted every time to ensure compatibility of all the parts together.
Napoleon faced a similar situation in France and remedied it by setting up a top-down code of law that aimed to dictate a full logical consistency. The
program; it is that our minds are far more complicated than just a system of laws, and the requirement for efficiency is far greater.
Consider that your brain reacts differently to the same situation depending on which chapter you open to. The absence of a central processing system makes us engage in decisions that can be in conflict
This is the most significant distortion and the one that carries the most consequences. In order to be able to put things in general context, you do not have everything you know in your mind at all times, so you retrieve the knowledge that you require at any given time in a piecemeal fashion, which puts these retrieved knowledge chunks in their local context. This means that you have an arbitrary reference point and react to differences from that point, forgetting that you are only looking at the differences from that particular perspective of the local context, not the absolutes.
When you take a gamble, do you say: “My net worth will end up at $99,000 or $101,500 after the gamble” or do you say “I lose $1,000 or make $1,500?” Your attitude toward the risks and rewards of the gamble will vary according to whether you look at your net worth or changes in it. But
where you will only look at your changes. The fact that the losses hurt more than the gains, and differently, makes your accumulated performance, that is, your total wealth, less relevant than the last change in it.
This dependence on the local rather than the global status (coupled with the effect of the losses hitting harder than the gains) has an i...
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Other aspects of anchoring. Given that you may use two different anchors in the same situation, the way you act depends on so little. When people are asked to estimate a number, they will position it with respect to a number they have in mind or one they just heard, so “big” or “small” will be comparative. Kahneman and Tversky asked subjects to estimate the proportion of African countries in the United Nations after making them consciously pull a random number between 0 and 100 (they knew it was a random number). People guessed in relation to that number, which they used as anchor: Those who
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million. But we saw John reaching $1 million having had a total of $10 million; he was happier when he only had half a million (starting at nothing) than where we left him in Chapter 1. Also recall the dentist whose emotions depended on how frequently he checked his portfolio.
System 1 is effortless, automatic, associative, rapid, parallel process, opaque (i.e., we are not aware of using it), emotional, concrete, specific, social, and personalized. System 2 is effortful, controlled, deductive, slow, serial, self-aware, neutral, abstract, sets, asocial, and depersonalized.
I found a confirmation of that as researchers in the heuristics and biases tradition believe that System 1 can be impacted by experience and integrate elements from System 2. For instance, when you learn to play chess, you use System 2. After a while things become intuitive and you are able to gauge the relative strength of an opponent by glancing at the board.
How? Say I test some chemotherapy, for instance Fluorouracil, for upper respiratory tract cancer, and find that it is better than a placebo, but only marginally so; that (in addition to other modalities) it improves survival from 21 per 100 to 24 per 100. Given my sample size, I may not be confident that the additional 3% survival points come from the medicine; it could be merely attributable to randomness.
At birth, your unconditional life expectancy may be seventy-three years. But as you advance in age and do not die, your life expectancy increases along with your life. Why? Because other people, by dying, have taken your spot in the statistics, for expectation means average. So if you are seventy-three and are in good health, you may still have, say, nine years in expectation. But the expectation would change, and at eighty-two, you will have another five years, provided of course you are still alive.
Causality: There is another problem; even assuming statistical significance, one has to accept a cause and effect, meaning that the event in the market can be linked to the cause proffered. Post hoc ergo propter hoc (it is the consequence because it came after).
Causality can be very complex. It is very difficult to isolate a single cause when there are plenty around. This is called multivariate analysis.
For instance, if the stock market can react to U.S. domestic interest rates, the dollar against the yen, the dollar against the European currencies, the European stock markets, the United States balance of payments, United States inflation, and another dozen prime factors, then the journalists need to look at all of these factors, look at their historical effect both in isolation and jointly, look at the stability of such influence, then, after consulting the test statistic, isolate the factor if it is possible to do so.
I have set up my Bloomberg monitor to display the price and percentage change of all relevant prices in the world: currencies, stocks, interest rates, and commodities. By dint of looking at the same setup for years, as I keep the currencies in the upper left corner and the various stock markets on the right, I managed to build an instinctive way of knowing if something serious is going on.
Unless something moves by more than its usual daily percentage change, the event is deemed to be noise.
A 7% move can be several billion times more relevant than a 1% move!
the static on the telephone line could be distinguished from the voice of your correspondent? The method is to consider that when a change in amplitude is small, it is more likely to result from noise—with its likelihood of being a signal increasing exponentially as its magnitude increases. The method is called a smoothing kernel, which has been applied in Figures 11.1 and 11.2. But our auditory system is incapable of performing such a function by itself. Likewise our brain cannot see the difference between a significant price change and mere noise, particularly when it is pounded with
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As they approach the sirens’ island, the sea is calm and over the water comes the sound of a music so ravishing that Odysseus struggles to get loose, expending an inordinate amount of energy to unrestrain himself. His men tie him even further, until they are safely past the poisoned sounds.
He can be tied to the mast; I can merely reach the rank of a sailor who needs to have his ears filled with wax.
The epiphany I had in my career in randomness came when I understood that I was not intelligent enough, nor strong enough, to even try to fight my emotions. Besides, I believe that I need my emotions to formulate my ideas and get the energy to execute them.
handle. If my brain can tell the difference between noise and signal, my heart cannot.
This problem has a more worrying extension; we are not made to view things as independent from each other. When viewing two events A and B, it is hard not to assume that A causes B, B causes A, or both cause each other. Our bias is immediately to establish a causal link. While to a budding trader this results in hardly any worse costs than a few pennies in cab fare, it can draw the scientist into spurious inference.
it. Popper or not, we take things too seriously.
My brain and my instinct were not acting in concert.
there is a difference between noise and signal, and that noise needs to be ignored while a signal needs to be taken seriously. I use elementary (but robust) methods that allow me to calculate the expected noise and signal composition of any fluctuation in
For example, after registering a profit of $100,000 on a given strategy, I may assign a 2% probability to the hypothesis of the strategy being profitable and 98% probability to the hypothesis that the performance may be the result of mere noise. A gain of $1 million on the other hand, certifies that the strategy is a profitable one, with a 99% probability.
Since my heart does not seem to agree with my brain, I need to take serious action to avoid making irrational trading decisions, namely, by denying myself access to my performance report unless it hits a predetermined threshold. This is no different from the divorce between my brain and my appetite when it comes to the consumption of chocolate.
knowledge. I am tired of the moralizing slow-thinkers who pound me with platitudes like I should floss daily, eat my regular apple, and visit the gym outside of the New Year’s resolution. In the markets the recommendation would be to ignore the noise component in the performance. We need tricks to get us there but before that we need to accept the fact that we are mere animals in need of lower forms of tricks, not lectures.
The next day, Carneades came back, stood up, and established the doctrine of uncertainty of knowledge in the most possibly convincing way. How? By proceeding to contradict and refute with no less swaying arguments what he had established so convincingly the day before. He managed to persuade the very same audience and in the same spot that justice should be way down on the list of motivations for human undertakings.
As the skeptics’ main teaching was that nothing could be accepted with certainty, conclusions of various degrees of probability could be formed, and these supplied a guide to conduct.
One author from antiquity who provides us evidence of such thinking is the garrulous Cicero. He preferred to be guided by probability than allege with certainty—very handy, some said, because it allowed him to contradict himself. This may be a reason for us, who have learned from Popper how to remain self-critical, to respect him more, as he did not hew stubbornly to an opinion for the mere fact that he had voiced it in the past. Indeed your average literature professor would fault him for his contradictions and his change of mind.
It was not until modern times that such desire to be free from our own past statements emerged.
Modern times provide us with a depressing story. Self-contradiction is made culturally to be shameful, a matter that can prove disastrous in science. Marcel Proust’s novel In Search of Time Lost features a semiretired diplomat, Marquis de Norpois, who, like all diplomats before the advent of the fax machine, was a socialite who spent considerable time in salons. The narrator of the novel sees Monsieur de Norpois openly contradicting himself on some issue (some prewar rapprochement between France and Germany).
Monsieur de Norpois is made to be ashamed of the fact that he expressed a different opinion. Proust did not consider that the diplomat might have changed his mind. We are supposed to be faithful to our opinions. One becomes a traitor otherwise.
He exhibits absolutely no embarrassment buying a given currency on a pure impulse, when only hours ago he might have voiced a strong opinion as to its future weakness. What changed his mind? He does not feel obligated to explain it.
The public person most visibly endowed with such a trait is George Soros. One of his strengths is that he revises his opinion rather rapidly, without the slightest embarrassment. The following anecdote illustrates Soros’ ability to reverse his opinion in a flash.
A few days later, the market rallied violently, making record highs. The protagonist worried about Saulos, and asked him at their subsequent tennis encounter if he was hurt. “We made a killing,”
Rozan saw Soros becoming distant. He then completely pulled the money, offering no explanation. What characterizes real speculators like Soros from the rest is that their activities are devoid of path dependence. They are totally free from their past actions. Every day is a clean slate.
Recall that epic heroes were judged by their actions, not by the results.
No matter how sophisticated our choices, how good we are at dominating the odds, randomness will have the last word.
We are left only with dignity as a solution—dignity defined as the execution of a protocol of behavior that does not dep...
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Grace under p...
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Cavafy was an Alexandrian Greek civil servant with a Turkish or Arabic last name who wrote almost a century ago in a combination of classical and modern Greek a lean poetry that seems to have eluded the last fifteen centuries of Western literature. Greeks treasure him like their national monument. Most of his poems take place in Syria (his Grecosyrian poems initially drew me to him), Asia Minor, and Alexandria.
“Apoleipein o Theos Antonion” (“The God Abandons Antony”)
