Role of Luck in markets and analogy to India's win:
India's win gives us fantastic investment insight!
If you haven't watched the innings, yet, here's how it went:
We needed 28 runs in 8 balls. This sounds like near impossible, but Kohli’s two sixes – fantastic shots – took it to 16 off 6. Doable, and all of this was the batsman’s skill.
The last over was crazy. After the loss of a wicket, we still needed 13 runs off three balls. Again, back to near impossible.
Then a no-ball (above waist high) thumped for six. The free-hit ball was first wide, giving another run. And then the next ball knocked the stumps down and ricocheted to no man's land, giving them three runs. One ball – a six, a no-ball, a wide, and three byes. This was incredible luck down to two from two.
And then, Karthik gets out stumped. Two from one, and looks ominous as Ashwin comes in.
The next ball is wide. This might be a skill, “induced” by Ashwin. Scores level and India’s still got a ball to spare. Ashwin hits that ball over the top to win.
Acknowledging that the universe somehow came together at the right time to make this happen, is quite crucial.
The analogy in markets:
You don’t know what will happen.
No one does.
So what we do, is to make the best of what we get – and try to induce things to happen in our favor.
You can’t depend on luck alone, but sometimes you’re going to need it.
What you have to do is stick it out till the end, and great things will happen.
So if you don’t do stupid things, you’ll win because other people will do silly things.
I am a firm believer in the role of luck in our lives. I don’t overrate its importance like some people do, blaming everything that happens or does not happen to them to their luck, their stars, their fate, etc. I think that is a cop-out, where people are ducking the responsibility of performance, which is often enhanced by the luck factor.
But leaving everything to luck is to abdicate responsibility for creating something that you desire in your life- like riches, success, fame, etc. Each of these happens a lot by design and the progress toward the goal here is either accelerated or delayed by luck.
When it comes to the markets, a lot of people believe that it is all a play of luck. Michael Mauboussin, one of my all-time favorite authors, in his fantastic book Success Equation examines the role of luck and skill in the markets. I am fond of comparing trading and investing in markets with the individual sport. I believe it is one of the closest analogies you can make for what happens in trading and investing.
Mauboussin has a table in his book where he places investing somewhere to the left of the scale (more luck) and in between betting on hockey and slot machines! Now, that really gives one a sense that investing success is mostly a function of luck. According to Mauboussin, a game like chess is all about skill. Now that is undoubtedly true. But one level short of betting on slot machines? I am sure a lot of people who are serious about investing would just balk at the idea of being told that they are almost gambling!
This is not to mean that something like roulette does not involve skills- it does. But it requires a huge number of iterations to prove its role. Similarly, there will be some luck involved in winning a chess game too but that is a very small proportion. In investing, Mauboussin writes, that where some luck is involved in deciding the outcome, a good process will ensure some consistent outcome, and that too, over a longer period of time.
What does a long period of time provide? For starters, it gives us time to practice and polish our skills. As we keep doing that we get better – meaning, we make lesser mistakes. So what time really does is to help us absorb the losses created. Then it allows the market cycles of intermediate and long-term nature to play out.
Our thinking may be short term but by allowing for time for the trade to come through, we are now taking advantage of the main market cycle to play out. This helps to boost the gains. Third, by creating a process that we work over a longer period of time, we also gradually reduce the level of engagement with the market. This too has a beneficial impact on the final bottom line. The more you transact, the more risk you run. So by giving time to your trades and investments to come through, you automatically reduce one of the risks.
Thus a process is a right way to get luck on our side. But the process necessarily has to run over a longer period of time. This can also be understood as a short-term process (such as day trading) that can also improve the results provided you look at the results over a longer period of time. This would require one to be consistent with the trading methodology and not change it every few days!
So, create the process, work it diligently and see luck start working in your favor!
Cheers!
End-Week Wisdom:
“I'm a greater believer in luck, and I find the harder I work the more I have of it.”
― Thomas Jefferson
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