Tuesday , September 17 2019
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How not to be an arrogant prat

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Summary:
Dan Davies has said that financial regulators should have been active spread-betttors, because only this gives them hard knowledge of how nasty margin calls can be. The same should apply to everybody who expresses a political opinion. The thing you learn from financial markets is that even your best ideas, your most diligently-research trades, often go wrong – and expensively so. Equity fund managers typically have only a few good stock ideas and most of what they do is either risk management or value-subtraction. And private equity managers expect many of their holdings to lose. What you learn from spread-betting or (in my case) having to stand on a trading floor after one of your calls has gone wrong is that the only thing that matters is the facts. However much smoke your friends

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Dan Davies has said that financial regulators should have been active spread-betttors, because only this gives them hard knowledge of how nasty margin calls can be. The same should apply to everybody who expresses a political opinion.

The thing you learn from financial markets is that even your best ideas, your most diligently-research trades, often go wrong – and expensively so. Equity fund managers typically have only a few good stock ideas and most of what they do is either risk management or value-subtraction. And private equity managers expect many of their holdings to lose.

What you learn from spread-betting or (in my case) having to stand on a trading floor after one of your calls has gone wrong is that the only thing that matters is the facts. However much smoke your friends and colleagues blow up your jacksy, if prices rise after you’ve shorted or fall after you’ve bought, you’ve lost. All that counts is the book. Heelboys

In punditry, it is otherwise. As Dan says, “being really aggressively unpleasantly wrong on your supposed subject of expertise has no downsides in the UK media.” Christopher Booker kept his job at the Sunday Telegraph despite his climate change denial. Those who told us that leaving the EU would be easy continue to expound despite their ideas being marked to market and found in the red. And those who greeted Theresa May as a new Thatcher continue to opine, heedless of their earlier error.

Granted, regular confrontation with expensive losses can turn traders into thick-skinned bumptious arrogant prats, who remember their successes but forget their failures – the sort who confuse the size of their pay-packet (often earned through mere asset-gathering or by state bail-outs) with the size of their talent.

But there is another reaction. This particular school of hard knocks can teach you humility – to be aware that the world is a more complex thing than your limited cognition can comprehend. The best traders and investors draw (at least) four inferences from this. Political pundits should too. These are:

 - Always ask of any item of news: is it noise (pdf) or signal (especially if it corroborates your prior belief)? One of the great errors traders make is to trade (pdf) on noise – something that looks like genuine information but in fact tells us nothing about the future or is even downright misleading. Theresa May called a general election in 2017, believing that council election results and opinion polls were a signal about her electoral prospects. In fact, they were noise. Everybody commenting on a poll now should therefore consider whether these have any more predictive power than they did then, or whether they are just noise.

 - Remember there’s a margin for error. If you are using a formal model, tell us what its confidence interval is and why past relationships break down. Do the same even if you are using an informal one: confidence intervals and parameter instability exist whether you know them or not.

 - Know the edge of your competency. As Charlie Munger says, you must know what you don’t know. There are no general purpose experts. Be honest about the gaps in your knowledge.

 - Value cognitive diversity. The best investors welcome people who disagree with them, because these help them test their own ideas better. Whilst echo chambers might in some cases yield useful information they are more likely to produce groupthink and overconfidence. Just because a nice guy agrees with you does not mean you are right. 

Although following these rules might well help you think better (I say this without of course always following them myself) I’m not sure they provide a viable business model. In the media – and certainly in politics - there is demand for overconfident prats. But then, there are trade-offs everywhere. One of these might be that there’s sometimes a tension between an ability to think properly and an ability to earn a living.

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