In Annie Duke’s excellent book “Thinking in Bets”, she points out a simple, yet often-overlooked aspect of decision-making. Too often, it seems, people gauge their decisions by the outcome they experience. Good outcomes are deemed to be the result of good decisions and bad outcomes are deemed to be the result of bad ones. But is that the right way to consider things?
All active trading is a zero-sum proposition. By definition, the only way one person can make money by trading is for the person she or he traded with to lose money. Collectively, the two traders are neither better off nor worse off except for the fact that they may have both paid transaction charges and one of them might also have a taxable capital gain to deal with. The problem is that, with modest exceptions, from March of 2009 to February of 2020 and from early April to late August, markets were rising sharply. If one were to simply ignore the six or seven weeks of a white-knuckled market drop in Q1, one might easily conclude that markets seldom drop and that, even when they do, they rebound smartly.
The phrase “a high tide raises all ships” seems particularly apt today. Markets around the world hit highs in early September and two months later, it seems most people are still acting as though the recent swoon is an anomaly. It might be. Then again, it might not be. The point that Duke makes repeatedly is that people tell themselves narratives that make them look good. If things work out, it is deemed to be due to superior skill, insight and talent. If they don’t, the experience is often dismissed as being a random bit of bad luck. You can’t win ‘em all.
The term Duke uses to explain this is “resulting”. Essentially, people assess the quality of their decision-making after the fact by looking almost exclusively at the outcome, rather than by the rigour or thoughtfulness that went into the decision in the first place. With the exceptions of Q4 in 2018 and the second half of Q1, 2020, the past decade and a bit has been remarkably benign for investors. Don’t let that favourable result convince you that you’re a great investor. The tide always goes out eventually.
