All posts by “Rajeev Mantri

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On Hindsight

Hindsight occurs when a surprising event takes place and the surprise is very brief, replaced almost immediately by a need to make sense of it. The individual has learned something from the event. For example, if there were two football teams that you considered equally-matched, and one of them trumps the other 5-0, they are no longer equally strong in your mind. One of them is clearly better than the other. This makes sense of their victory. It also makes it virtually impossible for you to re-construct that, earlier, you thought they were equal.

Now, we think that the team that actually won “had to win.” Why did it have to win? Because it won. It won because it was stronger. How do we know it is stronger? Because it won. This is hindsight. It has a huge effect on our thinking, it has a huge effect on investing behaviour, and it has a very pernicious effect, in that it teaches us something quite wrong about the nature of reality…

So, the pernicious effect of hindsight is that we get the sense, after the fact, that an event was predictable, so we get the sense that the world is predictable. We think the world makes sense, and that exaggeration of the coherence, consistency and predictability of the world means that we deny the real uncertainty with which we are faced in existence. And this denial of uncertainty in turn produces irrational action.

Daniel Kahneman

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Choose Smart People

The best new ideas always have unanticipated benefits. So it’s stupid to require people who want to do new things to enumerate the benefits beforehand. The best you can do is choose smart people and then trust their intuitions about what’s worth exploring.

– Paul Graham

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A Hacker’s Mind

If you understand a system well and deeply, you don’t have to play by the same rules as everyone else. You can look for flaws and omissions in the rules. You notice where the constraints the system places on you don’t work. You naturally hack the system.

– Bruce Schneier, A Hacker’s Mind

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The More A Theory Forbids, The Better It Is

It is easy to obtain confirmations, or verifications, for nearly every theory–if we look for confirmations. Confirmations should count only if they are the result of risky predictions; that is to say, if, unenlightened by the theory in question, we should have expected an event which was incompatible with the theory–an event which would have refuted the theory. Every ‘good’ scientific theory is a prohibition: it forbids certain things to happen. The more a theory forbids, the better it is.

– Karl Popper

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Science and Religion

Religion uses language in quite a different way from science. The language of religion is more closely related to the language of poetry than to the language of science. True, we are inclined to think that science deals with information about objective facts, and poetry with subjective feelings. Hence we conclude that if religion does indeed deal with objective truths, it ought to adopt the same criteria of truth as science. But I myself find the division of the world into an objective and a subjective side much too arbitrary. The fact that religions through the ages have spoken in images, parables, and paradoxes means simply that there are no other ways of grasping the reality to which they refer. But that does not mean that it is not a genuine reality. And splitting this reality into an objective and a subjective side won’t get us very far.

– Niels Bohr, Physics And Beyond

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Sources of Edge

Our portrait of real markets tells us what it takes to beat the market. Any of these can do it:

— Get good information early. How do you know if your information is good enough or early enough? If you are not sure, then it probably isn’t.

— Be a disciplined rational investor. Follow logic and analysis rather than sales pitches, whims, or emotion. Assume you may have an edge only when you can make a rational affirmative case that withstands your attempts to tear it down. Don’t gamble unless you are highly confident you have the edge. As Buffett says, “Only swing at the fat pitches.”

— Find a superior method of analysis. Ones that you have seen pay off for me include statistical arbitrage, convertible hedging, the Black-Scholes formula, and card counting at blackjack. Other winning strategies include superior security analysis by the gifted few and the methods of the better hedge funds.

— When securities are known to be mispriced and people take advantage of this, their trading tends to eliminate the mispricing. This means the earliest traders gain the most and their continued trading tends to reduce or eliminate the mispricing. When you have identified an opportunity, invest ahead of the crowd.

Market inefficiency depends on the observer’s knowledge. Most market participants have no demonstrable advantage. For them, the market appears to be completely efficient.

– Ed Thorp, A Man For All Markets