Van Tharp convinced me (as I kicked and screamed along the way) of a couple of market realities that have changed my way of looking at markets forever. As I implied, I didn’t take either of them into my belief system quickly – or easily. The first concept that I wrote about recently was this: We don’t trade or invest in the markets (or the Nasdaq or Nvidia or crude oil), we trade our beliefs about QQQ, NVDA, or CL. So, learning about and understanding our true deepest beliefs is essential to trading in a self-correcting and continuously improving way.
The second idea that I finally drilled into my head, thanks to Van’s diligence and after decades of “kicking against the goads”, was: The markets are not a math equation to be solved any more than parenting is. In fact, market participation is a lot more like playing poker than it is like taking the SAT—the college Scholastic Aptitude Test.
In poker and investing/trading, knowing the odds and probabilities is the minimum essential information – what I have called “necessary, but not sufficient” information.
That’s where the scariest word comes into play. It’s the one concept that is so powerful that it makes every trader and investor, from the seasoned professional, right down to the wet-behind-the-ears newbie tremble in their Chuck Taylor Converse sneakers.
It is, interestingly enough, the same word that strikes fear in the hearts of engineers, doctors, soldiers, scientists, ball players, weather forecasters and even lawyers.
It is at the heart of every discomfort you’ve ever felt when investing or trading.
It is UNCERTAINTY.
Uncertainty is the thing that we, as humans, are least equipped to deal with. And, without a doubt, the one constant in every good or great investor or trader that I’ve worked with is their ability to deal with uncertainty. The good news for all of us is this: There are many useful ways to deal with uncertainty and the havoc that it brings into the world of investing and trading. We’ll look into those in depth for the rest of this month.
In fact, it is really the final frontier. Whether consciously or not, most market strategies are based around taking advantage of some form of investor or trader Fear of Uncertainty.
Why Is Uncertainty So Central?
The markets can be characterized in many different ways. One of the most useful ways that I’ve had to come back to over and over again is that markets are just reflections of mass psychology. A concept that I’ve coined from this second great belief system that Van drilled into my head is this:
“The market is not a problem to be solved; it is psychology to be understood.”
If I approach the markets in an effort to evoke “scientific certainty” as one e-mail respondent to an article put it, or to solve a mathematical equation, I’m setting myself up for disappointment. The nature of the market continues to change, and it defies any effort to put it in a box for any significant length of time.
Conceptually, this is much like understanding the actions of another person. Even with my closest friends, the best I can do is to understand their tendencies—what they are likely to do in any given circumstance. And how they react to the exact same stimulus may vary from time to time based on their current emotional state or other inputs that I can’t discern. Doesn’t that sound a lot like the crazy 3, 4, and 5 sigma market moves we’ve seen in the last week?
Uncertainty, and developing tools and behaviors to deal with it, is so important because it is perhaps the central controlling concept in our decision-making process. The greater the uncertainty, the tougher the decision. As uncertainty is removed, decisions become much simpler.
Uncertainty is a concept that really strikes at the heart of what investing and trading are all about. It really is at the core of the nature of markets.
I’ve had a good time over the last year talking to different people about uncertainty (since I’m researching the very nature and application of uncertainty, the subject has been at the front of my consciousness). I have talked with folks about uncertainty in many areas of life, from the deeply personal (life expectancy, chance of contracting debilitating diseases and illnesses, etc.) to the mundane (what is the chance of being hit by lightning or stung by a bee) to the bizarre (when was the last time you discussed the Gaussian distribution for sugar cookie browning rates and the duration of first dates in the same conversation?).
But I did get to turn most of these discussions toward a conversation on market uncertainty. And while I got many different takes on uncertainty, the one most common response that I heard in handling uncertainty was that many, if not most, folks deal with uncertain outcomes by ignoring the uncertainty in one way or another.
People ignore uncertainty in two main ways:
Treating uncertainty as if it doesn’t exist. Many people think that outcomes for a great many things are predetermined. This usually comes from a belief that some large outside mechanism or institution is controlling things. For example, many people believe that the equity markets are “rigged” either by government intervention or by the action of large institutions like hedge funds, brokers, etc. (I can see the arguments play off in real-time, every now and again.) They then conclude that certain stocks can only go one way, or that individual investors don’t have a chance to succeed. Believing that things are “rigged” allows one to ignore uncertainty and jump to un-useful conclusions. In investing and trading, it’s tempting to think that market activities are being controlled (and in some less-liquid markets and time frames, I’m sure that big players can have an unusually large influence). But some traders use that mindset to push themselves to the conclusion that they can never get a leg up in the markets because the “big players” control everything. The typical response is, when things go well in an investment or trade, it’s because of something I did, and when they go poorly, it’s because of something that the “evil outside forces” did. Sure, that thinking gives us short-term emotional support, but it’s not very useful over time.
The Other Uncertainty Response? Treating uncertainty as if it can be eliminated. I traded some interesting e-mail strings on this subject with folks in various professions (including engineers, accountants, and programmers) who insist that their job is to eliminate uncertainty. I maintain that in most real-life situations, uncertainty can only be understood and perhaps minimized, but not eliminated. If we think that uncertainty is gone forevermore, especially if that is due to our diligence, we set ourselves up for really big problems when an unexpected event happens that is outside of our quantitative calculations or outside of assumptions. When we erroneously think the enemy is vanquished, we drop our guard. In investing and trading, we must always be prepared for an event, streak or other unexpected occurrence that will throw a proverbial monkey wrench into our plans.
Over the next two weeks, we’re going to look at how investors and traders deal with uncertainty and I’m going to introduce useful tools that you can use right away. The start-up company I’ve been working with for the last 12 months is designing and deploying cutting-edge tools and strategies to measure uncertainty, risk and volatility, and I can’t for you to join us as we grow this new community of investors and traders who use and improve new tools to use risk and uncertainty in our favor.
Best of all, it’s great to work with people who believe wholeheartedly in the concepts of Tharp Think and use them day-in and day-out.
If you have a story about uncertainty in the markets (or your personal or business life) you’d like to share, I’d love to hear it. Send an email to dr “at” drbartonjr.com or reach out to me on Twitter (X) @DRBartonJr.
And be sure to read the article next week about the innovative tools and developers I’m working with to make measuring uncertainty and risk a much easier part of your Daily Tasks of Investing and Trading.
God bless you and great trading,
D. R. Barton, Jr.
Twitter (X): @DRBartonJr
dr “at” drbartonjr.com