Trading Probabilities Versus Certainties
Mental Game of Trading
Featuring Dave Keller
Published on: June 4th, 2019 • Duration: 5 minutesDave Keller, CMT, president of Sierra Alpha Research, suggests traders should look at probabilities rather than certainties when making investment decisions. He says that nothing in the market is for certain, and acknowledges the imperfections with financial analysis.
DAVE KELLER: Hi there, my name is Dave Keller. I'm the president and chief strategist at Sierra Alpha research based in Cleveland, Ohio. So, I help financial advisors and institutional investors to make better decisions. And do that in a couple different ways, help them maximize returns, manage risk, and bring more mindfulness and awareness to their investment process. I also enjoy incorporating nonfinancial topics into financial topics. So, I'm a student pilot, I'm a musician. And so, a lot of the best ideas I think you can bring as an investor are learning from other disciplines, learning from other activities. And I write a blog at marketmisbehavior.com.
The words that I rarely hear investors mention that they should mention way more often than they do is I don't know or I'm not sure. And I think I'm not sure is the more painful of the two. Because if we think we know something, we all of a sudden decide we absolutely know something. And if there's one thing that is absolutely true, is we don't absolutely know anything about investments, no, we just don't. Everything is based on probabilities and never certainties.
The reason why we have so much trouble with that is because we are hardwired as humans to want to have certainty. We want to feel that experts know things that are unknowable. And we want to feel that there is an investment process which will be at perfection and won't have any issues. But if you've traded or invested one day, you'll know that that's not the case, right? Things are always based on probabilities. And the best thing you can do is set yourself up for a probabilistic set of outcomes. It's never for what's definitely going to happen.
The time recently, when that really hit me was the first time I've done better and better going on financial media, on television and online TV and things like that. But the very first time I did, I went on and I gave a very honest investment approach. I said, I'm really not sure what's going to happen. But I could see this happening. And I could see this happening. And if x happens, I would bet on this. And if y happens, I'll go on ahead.
And you know it was fine as about a five, 10-minute interview, like right on the way to the elevator, he said, it would be great if you could just be more certain about exactly what you're expecting. And I'm thinking to myself, okay, and I got on the elevator. I'm thinking, well, that makes sense. But I'm not certain and no one really is, but we need that certainty.
So, when I go on television and I have three minutes to pitch an investment thesis, you have to imply a certainty because you have a limited amount of time to drive home a soundbite, drive home a thesis. But if I'm really trying to manage a portfolio or coaching my clients to look at asset allocation, it's never based on certainties, you really don't know the answer.
And I would say one of my mentors used to say, Mike Epstein, who was a legendary trader, he was based in New York and actually was, if you know the CMT Association, he was the first one to connect the New York society with the Boston buy side technical analyst and link and turn the CMT association in the global organization it is now. But Mike always used to say them that know, know they know, and them that don't know, don't know they don't know. And the problem is, no one really knows everything about an investment approach.
So, in general, we have to accept the fallibility, the imperfection of financial analysis, and that's technical, fundamental quantitative, any of those things have an imperfection built into them, because we never going to know what the future holds. And the way you address that or the way you get past your struggles of uncertainty is to have a good game plan. Know that it's going to be imperfect and have a regular period where you review what you're doing.
So, what I coach clients is once a month, once a quarter, once a year, you have a regular period where you go back and review your wins, your losses, your best picks, your worst picks, your outperformers, your underperformers and try to pick apart how your tool kit can improve and try to minimize the uncertainty, maximize having a higher probability outcome to what you're doing.