A few years back I was lucky enough to chair a series of talks at The Royal Institution in London. The audiences were made up of finance types usually with a science background and the idea was to a get a series of speakers in to range across a number of topics that would spark lively debate. A particularly memorable speaker was the distinguished American physicist Larry Krause. His theme was the importance of questioning and critical thinking in science, and indeed in life in general.
Professor Krause raised an important idea that really resonated with me; namely when confronted by a problem or examining an issue, we tend to rush towards asking Why? This seems particularly true in my own field of finance. Why is the Dow lower? Why are people buying gold? Why are “those idiots” buying at these levels?
Krause suggested that we should not forget to ask How? Indeed, How, might often be the more appropriate question and may lead to a wider set of possible answers. By thinking about the How, it draws our mind to seek to understand the underlying mechanics and relationships that may help better explain things. We should acknowledge that this wider set of explanations can be a good thing – all too often we grab at the first answer to a problem, and fondly believe that it, must be the solution. Regrettably the human desire for slam dunk solutions knows no bounds and can lead to bad decision making.
By way of example he noted that in his own specialised field many outsiders, particularly non-scientists, spent a lot of time asking Why and Who created the universe, but rarely thought enough about How it came to be. As ever of course, there can be an uncomfortable twist – answering How may be devilishly difficult and potentially impossible. Hence the rush to concentrate on answering Why (or at least present a plausible scenario) and quickly move on, triumphantly announcing the issue was “solved”.
But why may answering How be impossible? Well some of the most difficult issues we face do not readily give up the answer to How. We have to understand that many interactions in life; science, markets, business, and our own behaviour do not always follow predictable linear paths. The past may be an extremely poor guide to the future, and so teasing out the structure or pattern of a current situation and how it may unfold may be impossible. We find this doubly a problem as humans are very attracted to pattern matching, finding patterns in random or noisy data that not really there. (The age-old example of the supposed image of Jesus on burnt toast comes to mind).
So tackling How can mean a very big challenge. In recent years interest in and the application of Complexity Science and understanding non-linear networks has attracted a lot of attention. This is still very much a developing field, but decision makers need to be aware of it might unlock the How puzzle and lead to a wider set of better decisions.
If you are interested in learning more about Complexity, and its applications I would suggest the following links:
This is a short extract from my book Financial Speculation. Its a quick look at two key components to successful investing as espoused by John Maynard Keynes. To me it is timeless advice that I try to adhere to.
Animal Spirits and Beauty Contests
Perhaps as a final observation on Keynes activities we should consider the fact that he never published any work on his secret investment techniques etc., though his views and attitudes are well documented. In particular Keynes wrote interestingly about speculation and what he called ‘Animal Spirits’. He noted that most market players are driven by optimism rather than mathematical expectation, and he was an early observer of one of the most corrosive of market practices – excessive activity or overtrading. He correctly realised that when under stress people often adopt active roles for the sake of it. Such is usually a substitute or a displacement activity, or as a way of trying to shake off the stress. Many people feel stress when involved in financial markets and they often alleviate this with quite manic trading activity. Bizarrely they trade even more ferociously when in fact they should calm down and draw back. Though in fact this only one side of the ‘behavioural’ coin in market psychology, the other big problem is curiously the exact opposite, freezing and being unable to act to stop losses from running out of control. Trading like so many things requires a happy medium of activity – few of us seem to be able to do this on a consistent basis.
Keynes also saw the problem of market speculation and prediction as akin to trying to guess who would win a beauty contest; he compared speculation to a newspaper beauty contest, where one is asked to pick out the prettiest faces among hundreds of photographs; and also most crucially to predict which is the most popular choice of all the entrants in the competition. So for example you may pick contestant number 54 – but sense that girl number 23 is the most popular. This is akin to looking at say the FTSE 100 list of stocks and you decide that you really like BP – but realise that the market really likes Vodafone.
Keynes held that to be successful in investment we have to choose not the ones we think are the “prettiest”, but the ones that we think everyone else will select. This piece of market thinking demolishes much of the supposed value of market analysts and commentators – what’s the point in knowing the best oil company in the market if all the price action is in say transport stocks? When Keynes first postulated this idea in the 1930’s it was considered somewhat radical and certainly didn’t conform to the standard views of rationality and assessing financial markets and assets in terms of fair value etc. Over time though, this idea has been developed further, now with a lot of interest being shown in market behaviour and psychology – though many market players and intermediaries seem to ignore it.
Finally, once again Keynes seems to prove the rule that successful market operators let their results speak for themselves. Only the also rans and hopefuls promote their ‘secret’ investment theories and systems, the successful just do it.
Gerald Ashley on Uncertainty
Above is a link to a podcast I did recently with Christian Hunt of The Human Risk Podcast about uncertainty, where I slide in comments on American Wrestling, Sky Diving, Rory Sutherland and Keith Richards no less.