Assumptions – Where to look to find the weak spots in theory

If you ever wake up one morning and decide to tackle dogma, then the best place to start your quest is in pulling apart the assumptions that are invested in any theory. I recently posted an article on Ed Thorp and his foray into game speculation where the mathematical truisms of theory were overturned by the reality of physical systems.

Of course those mathematical models had a big role to play in tainting the field of speculation with ‘voodoo ill will’ and a persistent stigma that still persists….and so, as a result we now have a cute group consensus definition of gambling as a negative sum game…aka a neat convenient human categorisation that is distinct from the notion of prudent prediction or speculation…..but then we have the skilled poker players often called gamblers like Annie Duke who with a wry smile will say….’whatever floats your boat pal’ as she craftily emasculates you at the poker table and leaves you wanting.

Speculation is inherent in all of us. It is about predicting an uncertain future. Speculative gambling is not a sin in itself, but it is the impact of exploitation of the human condition that is especially when you add addictive nitrous to the equation called debt/leverage when the impacts of speculation are magnified…but then again, exploitation is present everywhere when a transaction is involved as it merges with a cherished human definition called competition which aligns with our nature as a biological species… where do you draw that convenient and subjective human line?

When you don’t know where to draw that line for others, then that is symptomatic of an incoherent mindset, and you then know to turn that question towards yourself as you are not currently equipped with a mental model to respond on behalf of others.

Don’t be a sucker to group opinion. The best way for you to overcome your ability to be exploited is to become a sceptical scientist and never trust anything on face value. Empirically test it on your own terms….and not others.

As Warren Buffet said…”if you are at the poker table and you don’t know who is the patsy….then you are the patsy” 🙂

The best way to challenge any purported truism is through examining the outcomes in terms of the mathematical expectation of the testing process yourself using very large sample sizes that allow for the Law of Large numbers to kick in.. What I mean is that you need to start bench-marking performance against yourself and not others as you need to understand the assumptions buried within your biases as opposed to simply accepting other opinion as within those opinions are biases you will never detect.   

You use others to acquire ideas and build your knowledge base in order that you hopefully make better informed decisions using more robust mental models…but the means by which you assess your performance is by validating the robustness of your mental models using your own track record….not others.

For example a frequent trick used by dodgy salesman is to advertise system win rate. Do not use use win rate as a guide to success as luck plays a large part in the perception of reality. You can toss a coin many times and still get heads…..but any bias is only ever revealed with the Law of Large numbers. Mathematical expectation is a more subtle definer than win rate alone and is obtained by examining the outcomes of tests using a sustained repetitive process over a large sample size that evaluate the win rate, the loss rate, the average win rate and the average loss rate. This is what determines whether or not you have an edge (still defined within a confidence interval to allow for error or system adaption) in an uncertain world.

In complex systems there is no black and white. It is all just different shades of grey. Decision making within that context must therefore be probabilistic in nature and adaptive in nature. There is no right or wrong, there are just decisions and it is the quality of the decision which is important in terms of the optimal outcome or that which delivers positive expectancy…but to make better decisions you need to unbind those biases that restrict the power of our mental models.

For example, we might hear a statement from a supposed clever fellow that you can earn 100% per month using a well thought out system in binary options………reaaaaaaalllllllllyyyy? 

Now despite the warnings and despite our supposed rationality we still scratch our heads and think….I wonder. Then onto….”well you got to be in it to win it”….and then the supposed rational thinker becomes a blob of malleable putty. 

Well despite the incredulity of this predatory selling  statement there are still patsy’s out there who absorb this stuff as fact or possibility because they simply do not have mental models that are sufficient to divorce reality from mere belief systems. Now I was a patsy in my past life and still am in various degrees, just as we all are at times…though we might not like to admit it. How did I overcome my propensity for this human frailty….well I got out my spreadsheet and started testing the systems themselves using extended data sets….and lo and behold my naive opinions of heady returns and infinite riches were shattered in an instant and my patsy resilience was increased to the power of 10.

It took the act of applying the scientific method on my own behalf to release the demons of bias and incoherence that dominated my thinking processes. This is what learning and building better mental models is all about. It was not that I negated the statement from the outset (ok I am lying here a little bit)…but rather that in my undertaking of my own long range testing I found that the statement simply did not coincide with the best I could achieve applying my own mental models. It may not be “wrong “as a definitive statement is never recommended….. but according to my more informed mental models it certainly smelt like a rat which was very very improbable.  It is through this process that you find you can shatter your innate biases that bind you You won’t achieve this by mere acceptance of opinion as you will become indoctrinated as opposed to informed.

In today’s modern liquid markets that are governed by an ever increasing participant mix of opinion, when you drill down into the notion of randomness, speculation, investment….you name it…… the reality is that it is very hard to distinguish the difference between gambling or prudent prediction, trading or investing. At the heart of it all with no truisms to lean on, there is just a probabilistic outcome where the most optimal outcome matters.

The bottom line is that our human categorizations are based on group think models only that may or may not significantly depart from the underlying reality. In any complex ‘classical’ system where non linear power  laws lurk, the very small assumption  can lead to large departures from reality. It is intractability or the limits of our ability to understand or calculate complexity ,not any underlying truism that forbids our ability to calculate.

Those little assumptions that made the calculation easier to do frequently turn out to be the seeds of dogma….which therefore amounted to a false imposed hallucination of the mind that departed from the reality when broken down. 

We often confuse intractability with impossibility, and that is what constrains progress in our understanding of how complex systems work such as the financial markets, the microscopic world, ourselves, our ecologies, our planet, our solar system, our universe ..indeed almost everywhere we look we are confronted in reality with complex systems at work. This is why the process of the scientific method is never complete and that there is never actually any truism….only a best fit model of the time.

Where we tend to confuse things is in the naive adoption of the principle of parsimony. We are fed the notion that simple is always preferred but complex systems themselves use fundamentally simple principle components to deliver ultimate unfathomable complexity….but the reality is that the actual simplicity is deeply hidden. What we choose as simple however in our assumptions to assist our calculations can be light years away from the actual simple that is required to stretch our domain of reality. Choosing the correct simplicity is as difficult as finding a needle in a haystack. Hell..let’s take simple as being a string of constrained vibrating energy but don’t worry about the accompanying assumptions of 10 dimensions required to make that model work…cause it’s simple *sniggers.

Where the elegance in simplicity arises from is the way in which the correct choice of simplicity is able to stretch the domain of enquiry with your mental models to achieve that light-bulb moment of expanded awareness. It is not an easy choice however and the more that assumptions have a role to play in any definition,  the more chance that we have a significant departure from reality down a long path of false leads.

The adoption of assumptions is a calculated guess at simplicity or a heuristic statement to make calculation easier and inevitably is where the apparent truth statement can be shattered.  We as a species adopt assumptions in everything we do to shortcut the processes of understanding the total context. In reading this article for instance you are probably doing this now in assessing my character.

For the scientist in us all, we need to rail against dogma, assumptions and associated truth statements . It is what holds us back or leads us down false paths. We all need to challenge every assumption we hear and do so continuously as complex systems adapt.

There is no better arena to hear persistent dogma than the financial markets themselves. The reason for this prevalence of apparent factual certainty’ is due to the incredible complexity and intractability that exists within these moving feasts. Plus you can spout any gobbledygook and get away with it without fear of recourse because it is complex.

Ed Thorp had a relatively easy time with the casinos as the environments of that type of complex system were far simpler than what is present in the interconnected financial markets of today…..however what drove Ed to challenge prevailing dogma in the casinos was his identification and acknowledgment that man’s human models called theories are simply best guesses based on spurious axioms and assumption that simply turn intractability into something understandable for the time being. 

The same can be said for any scientist who overturns the theory of the day in recognition that the model is only representative of a narrow domain of conditions that depart from the actual reality.

Unfortunately the dogma however starts to infiltrate our language such as our definitions, our prevalence to objectify apparent things with ‘nouns’ to elevate them to reality as opposed to the underlying processes of importance in complex system (eg. the verbs) and then onto our thinking processes themselves where we hallucinate an alternate reality of indoctrination and incoherence. Our propensity to adopt truth statements really is a vicious circle.

So the moral of this tale is that ….we really aren’t as clever as we think we are. Never accept any truth statement. Question everything. The way you succeed in life is to forge your own reality, not someone else’s reality….and then you may find that your mental model gives you a leg up in this world with an indefatigable edge in any endeavor you do.

It is not about being right or even righteous….it is about exercising that brain like any other muscle in your body to maintain an edge that enables you to not simply be a victim of luck. Ensure you develop better models of the reality than a false version of any alternate reality being dogma. That’s how you stay ahead of the crowd and keep sharp.

This provides a good segue into a very informative podcast with Annie Duke…….enjoy 🙂

Annie Duke Interview with Michael Covel on Trend Following Radio

More from Annie here.

Risk Schmisk | Annie Duke | TEDxGeorgetown

Mastering the Decision-Making Process with Annie Duke | BP Podcast 297

Trade well and prosper

Rich B

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