How to Beat the Odds at Judging Risk
My first thought when coming across a link to this article was a literal “WTF?????”
I quickly glanced at the date … 15 May. And this article was published on, what … May 11.
WTF? Why did it take me so long to find this article?
I read through many, many trading-, economics-, and finance-related blogs/tweets/articles and I didn’t see any reference to this article until I read through one of my ‘relax time’ blogs (Lifehacker Australia, so HUGE h/t to them). Of course, maybe I’m reading the wrong trading-,economics-, and finance-related blogs/tweets/articles. OR, I’m reading the right ones and just missed this article. Whatever; rant complete, on with the post.
Good article. Plenty in it for risk managers.
Most of us have to estimate probabilities every day. Whether as a trader betting on the price of a stock, a lawyer gauging a witness’s reliability or a doctor pondering the accuracy of a diagnosis, we spend much of our time—consciously or not—guessing about the future based on incomplete information. Unfortunately, decades of research indicate that humans are not very good at this. Most of us, for example, tend to vastly overestimate our chances of winning the lottery, while similarly underestimating the chances that we will get divorced.
Psychologists have tended to assume that such biases are universal and virtually impossible to avoid.
But certain groups of people—such as meteorologists and professional gamblers—have managed to overcome these biases and are thus able to estimate probabilities much more accurately than the rest of us.
Are they doing something the rest of us can learn?
Can we improve our risk intelligence?
You bet (LOL).
… an expert in the field of decision science, points to several characteristics of groups that exhibit high intelligence with respect to risk.
First, they tend to be comfortable assigning numerical probabilities to possible outcomes. …
It helps, too, if the group makes predictions only on a narrow range of topics. …
Finally, groups with high risk intelligence tend to get prompt and well-defined feedback, which increases the chance that they will incorporate new information into their understanding.
Check out point 2: It helps, too, if the group makes predictions only on a narrow range of topics. I don’t know about any of you out there, but what I’m doing is NOT rocket science.
And its Narrow … Is the frikkin’ thing going up or down?
How narrow is that? Its just binary. Up or Down?
Like I said, not rocket science.
And, seriously, its only gotta move enough for me to get my stop to b/e, at least. Gravy after that (low carb, preferably :-)) So, How hard can it be?
Sure, I love the navel-gazing as much as anyone else …Is Greece going exit the Euro, and when? Is there another round of QE coming, and when? Blah, blah, blah … But for a few hours each day its much simpler: Up or Down? Again … How hard can it be?
OK, the final point too:Finally, groups with high risk intelligence tend to get prompt and well-defined feedback, which increases the chance that they will incorporate new information into their understanding. When I’m trading I’m not investing … it quickly moves in my favour or it doesn’t. That’s fast, well-defined feedback. Learn from it (yeah, I’m talking to myself as well here).
BTW, have you checked out the work of Dr. K. Anders Ericsson … the bit in the article about prompt and well-defined feedback fits right in with his models of expertise development. Check him out (if you haven’t already).
Just by becoming aware of our tendency to be overconfident or underconfident in our estimates, we can go a long way toward correcting for our most common errors. … As for the rest of us, we could estimate the likelihood of various events in a given week, record our estimates in numerical terms, review them the next week and thus measure our risk intelligence in everyday life. A similar technique is used by many successful gamblers: They keep accurate and detailed records of their earnings and their losses and regularly review their strategies in order to learn from their mistakes.
C’mon. This is a no-brainer, right? Right?
No one can be great at estimating all types of probabilities in all situations. But given the right conditions and the right kind of self-reflection and practice, we can all make substantial improvements in our risk intelligence.