The difference between knowing something and acting on it

Well, this is going to another of those posts which uses concepts from the world of finance and the world of probability to make generalized observations on life.  Dear reader of the blog,  you have already been forewarned :)

So this is an insight which came to me while I was trying something at work.  It isn't any ground breaking insight ( some of these concepts are known in the world of finance and markets anyway) but, here, I am just trying to see if I can take away something more generalized for life as I see it.

The world of investing,  trading and finance, is by its nature informationally fuzzy,  in the sense , that anything you know 100% for sure , is in all probability already priced in.  The challenge,  the joy,  and the rewards lie in figuring out something which you don't know for sure,  but yet can figure out with some probabilistic level of certainty.  And to some extent, this is true of life as well --- this part of figuring out stuff interests all of us. In the way Holmes did at times,  "once you have eliminated the impossible, the remaining explanation however improbable,  is the truth". Although we all like being a good detective,  figuring out things by observation and/or elimination, that's rarer, both in life and finance.  We sometimes have to just go with patterns we see even if there is a risk of confusing it with patterns we seek.

But what do we do once have done that? That's in a way the harder bit! Not all information may be actionable. Some maybe actionable but the payoff from it may not be stuff that changes your fortunes.  Let's say hypothetically , assume as a random example. you figure out that the current bout of AI optimism is a bubble , but you don't have a way to short stocks and even if you do, the timing is uncertain. All you can do , is use this piece of inference to play it defensive- in order to play attack ( like  for when you can deploy your money once the bubble has  burst) another day. I will come to this bit of defensive and aggressive in just a bit. 

But before that,  the broader point.- Your observations,  your research,  your deductions, the patterns you see, might lead you to deduce an information X, that too with only a certain degree of probability and confidence. How do you use that information X is a completely different ball game all together.  Sometimes you want to figure out a Y, and figuring out X might mean a high probability of Y.  But your interest is in actually knowing Y. High probability is no guarantee, and you don't even know if X itself is certain. There's a lot of scope for things to be lot in translation and pattern recognition. 

And yet, there are some heuristics which you can apply. The caveat here,  is unfortunately you cannot apply it to places where it is an one-off or a binary situation. When you however make decisions repeatedly, and over long periods of time,  these heuristics are useful:

1. Figure out a system , or a set of principles and rules which work out for you,  be it markets or life, with a reasonable level of probability or accuracy. Remember , you are never going to get 100% certainty,  be it in finance or life.  Roger Federer said once that he won just 54% of points but 70% of sets and 80% of matches.  Something that works for you with even a moderate degree of  accuracy, is good enough over the long run, if you can do it again and again. Play the odds, on the side of the the probable. Just do it over and over again.

2. But,  and this is important.  Just like all of the points in a tennis match are not equal and not every decision in finance has the same payoff, same is the case with the decisions you make during your life as well. You have a certain principle , value and behavioural system that works well for you. Sticking to it helps compound the payoff sure. But there's a little bit more you can do.

3. Look for the asymmetric payoff. Being right is good,  deducing information is good.  But in the world of finance , probability and in life , you have to ultimately make bets. And for that, asymmetric pay-offs matter.  Let's say the principles and the systems you follow make you defend 80% of the time and be aggressive 20% of the time.  That definitely helps you avoid catastrophe but your upside is simply capped. It also puts pressure on you to get the remaining 20% correct to an even greater extent when the system says "go attack". 

So , you have to be tilted towards risk taking. Not in the gambling sort of way but you have to bias yourself towards "measured risk" ,  even if it means your "system" becomes less accurate probabilistically.  Fortune favors the brave,  they also favor the optimistic.  You have to think that tomorrow will be better than today, even if sometimes that might not always be the case! Even if sometimes its difficult to think that! Because,well , there's no fun in getting a doomsday scenario right.  Or a scenario with a meh payoff. And what's more,  in many cases,  tomorrow is indeed better than today!

4. Bet ("reasonably") big when things are good,  and when you are betting on the optimistic scenario. Because even with a good set of principles to guide you,  you will not get your optimistic bets right all the time. You might set up yourself for disappointment, embarrassment. But if you have the chance to do the same bet again and again and again and have trust in a "system"/ a set of principles/ your skill etc,  that works, then this is the best way to ride past those disappointments, embarassments and maximize your payoff.

How big is reasonably? That's tricky. One heuristic is that you need to avoid catastrophe with any single risk you take. Which is the obvious easy bit and part of the asymmetric payoff you are anyway seeking. But sometimes a series of big bets,  with a bit of bad luck,  can go catastrophically wrong too. Which brings me to the last point.

5. Ride your luck and momentum:  Yes, luck is a thing in life, as is momentum. Momentum is a thing in financial markets too. Life and markets both don't really zig zag every single day or return to the mean. So when you are having the momentum,  that series of good luck etc,  just ride it and bet big and optimistically. Because those times aren't going to last forever.

So here's the summary: find a system or a set of principles and behaviours that work, bias the system towards optimism and risk taking even if it means diluting how often it works, bet asymmetrically, bet big when the going is good and in times when your system is asking you to be optimistic,  and the last bit - don't go too defensive even when the system is telling you to be pessimistic.  You have to be defensive in a measured way.  Because, eventually playing defense is always for living to fight another day.

Ufffff that's a lot of gyan here,  and unlike some of my posts , which as I acknowledged in an earlier post as well, may have a whiny tinge,  this one is on the optimistic side as well!

Now if only I knew a lot of this,  much earlier in life! But then again, getting back to the headline of this post, there's a difference between knowing or inferring something and acting on it!

And perhaps after all the gyan that I have given here,  that really is the issue! The difference between inference and action is well, also one of fear. The fear of failure, the fear of not being validated, the fear of embarrassment. The difference between inference and knowledge on one hand,  and action on the other is well, if you think about it,  us viewing even the ratiomally small risk we want to take as catastrophic!