Hedgehogs and Foxes – Don’t be stuck in your views; be willing to revise them quickly when new information comes in.

Philip Tetlock’s work (following on from Isiah Berlin) has, IMO, great applicability to trading. I’ve been meaning to write a blog post or two about it for a long time but haven’t done so. Up ’til now.

I was prompted by this article in the HBR (h/t Abnormal Returns for this article, though there are many sources referring to articles about Tetlock and his work).

I’ve excerpted a few of what I believe to be the key points in the HBR article. I’ve edited the quotes, so they are not word-for-word with what is written in the article (article is linked above for a fuller reading … these are just notes).

First, what is a ‘Hedgehog’ and what is a ‘Fox’?

In his wonderful book Expert Political Judgment, psychologist Philip Tetlock (following the lead of Isaiah Berlin), divided the world of political forecasters into hedgehogs and foxes:
– Hedgehogs knew one big thing and sought, under the banner of parsimony, to expand the explanatory power of that big thing to “cover” new cases; These hedgehogs are also much more likely, Tetlock found, to be wrong.
– The more eclectic foxes knew many little things and were content to improvise ad hoc solutions to keep pace with a rapidly changing world. Foxes see the world more clearly than hedgehogs.

I think of those with fixed views (eg. the perma-bs) as hedgehogs, interpreting data to fit their theories rather than letting the data help form their theories.

the best forecasters:
are distinguished by three characteristics:
(1) an intense curiosity about the workings of the political-economic world;
(2) an intense curiosity about the workings of the human mind;
(3) cognitive crunching power (“fluid intelligence” and a capacity for “timely self correction”).

I think these characteristics can be adapted to the world of traders … in brief:
(1) Figure out what is actually going on;
(2) Figure out how the market (i.e. those trading the market) are interpreting what’s going on … how is the market positioned?
(3) Have “a capacity for “timely self correction””. (For me, this is not only changing views and therefore market positions as events dictate, but also feeds into risk management).

Paul Saffo wrote in HBR that:
Prediction is concerned with future certainty; forecasting looks at how hidden currents in the present signal possible changes in direction for companies, societies, or the world at large. Thus, the primary goal of forecasting is to identify the full range of possibilities, not a limited set of illusory certainties.

On viewing the market in the context of possibilities, rather than black-and-white is it going up or down? (Although, as a directional trader I do have to finally make an “up OR down” (buy OR sell) decision)

When Saffo says to judge him not on whether his forecasts come true but on his logic, he’s effectively removing a hard performance metric and replacing it with a soft one. But he’s right that for many purposes in business and other fields, having a sense of the range of possibilities is more valuable than an explicit prediction.

I would sugggest that when doing a postmortem on a trading decision (I’m substituting “trading decision” for “forecast”), assess the quality of the decision separately from the result. We’ve all had good decisions result in losing trades, and bad decisions result in winning trades … the market is a probabilistic machine). Mind you, watch out for the trap of having too many ‘good decisions’ resulting in losing trades … ask yourself if the process of reaching ‘good decisions’ is working for you … is your process ‘good”, or maybe not (I am, of course talking about myself here too). Something to think about.

And finally, and a good way to wrap this up:

the key is to “hold strong opinions weakly.” Don’t be stuck in your views; be willing to revise them quickly when new information comes in.

I have nothing at all to add to or modify that. Great advice.

Twitter: @FinMktTrader

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