Recently I read Nassim Nicholas Taleb’s book Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets which showed how we often mistake skill for luck when dealing with random events. Part of the reason why we make these mistakes is due to biases that we are unaware of, or do not take into account. Even when we think we’re evaluating things perfectly rationally we have inbuilt biases which can effect our evaluations.
While Taleb’s book mostly uses finance and financial markets as a basis for examples, I’ve found that finance can often provide us with examples and strategies for dealing with situations in everyday life outside of financial decisions.
One of our biggest biases is to rely too much on the past when trying to determine what can happen in the future. Obviously, the past is the only thing we really have as a basis when trying to predict the future, but the past can also restrict our thinking, as we tend to think that the future will look much like the past and don’t sufficiently plan for unexpected outcomes. Regarding this Taleb said:
We could be either too lax or too stringent in accepting past information as a prediction of the future. As a skeptic, I reject a sole time series of the past as an indication of future performance; I need a lot more than data. My major reason is the rare event, but I have plenty of others.
On the surface, my statement here may seem to contradict earlier discussions, where I blame people for not learning enough from history. The problem is that we read too much into shallow recent history, with statements like “this has never happened before,” but not from history in general (things that never happened before in one area tend eventually to happen). In other words, history teaches us that things that never happened before do happen.
When the unexpected happens we tend to be shocked and surprised, even though history is filled with instances of the unexpected happening. This surprise at the unexpected can be partially explained by two different biases, normalcy bias, in which we tend to expect things to continue happening in much the same way they have been and hindsight bias. When we look back at the past, things tend to look much less random and far more predictable than they actually were. Taleb explained hindsight bias by saying:
Past events will always look less random than they were (it is called the hindsight bias). I would listen to someone’s discussion of his own past realizing that much of what he was saying was just backfit explanations concocted ex post by his deluded mind.
In hindsight we can generally easily see why something happened that was completely unexpected at the time and wonder how we did not see it coming. The lesson that this should teach us, is that we are not being imaginative enough or looking for the possible, but improbable scenarios.
A book that illustrates how principles and lessons from finance can be applied to other areas in life, including sports, is Michael Lewis’ Moneyball: The Art of Winning an Unfair Game, which chronicles how the Oakland A’s used statistics and widely held biases, to find talent in unlikely places and build a winning baseball team on a budget. Lewis explained the connection between economics and baseball as:
Paul wanted to look at stats because the stats offered him new ways of understanding amateur players. He had graduated from college with distinction in economics, but his interest, discouraged by the Harvard economics department, had been on the uneasy border between psychology and economics. He was fascinated by irrationality, and the opportunities it created in human affairs for anyone who resisted it. He was just the sort of person who might have made an easy fortune in finance, but the market for baseball players, in Paul’s view, was far more interesting than anything Wall Street offered. There was, for starters, the tendency of everyone who actually played the game to generalize wildly from his own experience. People always thought their own experience was typical when it wasn’t. There was also a tendency to be overly influenced by a guy’s most recent performance: what he did last was not necessarily what he would do next. Thirdly–but not lastly–there was the bias toward what people saw in their own eyes, or thought they had seen. The human mind played tricks on itself when it relied exclusively on what it saw, and every trick it played was a financial opportunity for someone who saw through the illusion to the reality. There was a lot you couldn’t see when you watched a baseball game.
The A’s were able to take advantage of biases on the part of other teams, including their heavy reliance on recent past performance as an indicator of future performance to acquire talent for less. They also exploited the other team’s failure to consider certain types of people playing a position, just because that type of person hadn’t done it before. On the team’s ability to do what had never been done before Lewis said:
As the thirty-fifth pick approaches, Erik once again leans into the speaker phone. If he leaned in just a bit more closely he might hear phones around the league clicking off, so that people could laugh without being heard. For they do laugh. They will make fun of what the A’s are about to do; and there will be a lesson in that. The inability to envision a certain kind of person doing a certain kind of thing because you’ve never seen someone who looks like him do it before is not just a vice. It’s a luxury. What begins as a failure of the imagination ends as a market inefficiency: when you rule out an entire class of people from doing a job simply by their appearance, you are less likely to find the best person for the job.
Sticking with what has worked, or been done, in the past may continue to work in the future, but is unlikely to lead to unprecedented success, instead you must look for the opportunities that others have not, or cannot see, to reach new levels of success.
When making predictions about what is going to happen, we should be aware of how the past can bias and restrict our thinking and not just look for what seems like the most likely scenario, but also for the unexpected or improbable. By trying to think of the situations which may seem ridiculous or impossible, no matter how unlikely, and having a plan ready for them just in case, we can equip ourselves to take advantage of, or avoid them, while others are struggling to react. Because the one lesson we should really take from history is to always expect the unexpected.