Feedback Loops And Checklists
Annie Duke wrote in Thinking In Bets the importance of learning from mistakes.
In the stock market, and especially in trading, it’s easy to fool yourself. The famous scientist Richard Feynman once said that the first principle is that you must not fool yourself and you are the easiest person to fool. Trading involves decision-making all day long, and decision-making ends with a good or bad outcome.
Unfortunately, we don’t know the outcome when we make our decision but tend to confuse the quality of the decision with the outcome (good or bad).
Most people tend to rank their decisions on the outcome: A good outcome is a result of a good decision, and a bad outcome is based on a bad decision. We judge the quality of our decisions on the outcome, not the other way around.
But you can have a good outcome despite a bad decision, and you can have a bad outcome even though the quality of your decision was good.
We all fall prone to the resulting bias
Take a moment to reflect on your best decision during the last year. Likewise, spend some thinking about your worst decision. Most likely, you argue that the best decision preceded a good result and the worst decision preceded a bad result.
However, that’s because we judge our decisions by “resulting”.
A good decision sometimes results in a bad outcome, and a good outcome can happen after a bad decision. We often fool ourselves by judging the quality of the decision based on the end result.
If you have a resulting bias, you’ll have problems learning from your decisions. To avoid “resulting”, you need to focus on the decision process.
Feedback loop
Below are some important factors for successful trading:
- Make sure you have a rational framework for your decisions. Use a checklist (see below).
- All your decisions should be done in a way as if
- Be aware of your trading biases and look for contrarian opinions.
- Don’t take shortcuts.
- Rinse and repeat.
Remind yourself:
- Life is a perpetual state of learning and learning compounds over time.
- You learn the most by having skin in the game via betting. Ask yourself: How much do I want to bet on this outcome?
- Be truthful to yourself and find knowledgeable people that sometimes disagree with you. If you are wrong, it means you go to bed wiser.
Checklists
In 2009 Atul Gawande, a professor of surgery, published a book called The Checklist Manifesto – How To Get Things Right. The book is a good read and is relevant for most professions, not to mention what we do in our private lives. Why? Because in a complicated world it’s easy to make mistakes by skipping important procedures or tasks.
Most people have probably seen from movies or air crash investigations how pilots run checklists before takeoffs. The majority of all airplane accidents are still caused by human mistakes. Most mistakes happen because one task or procedure was forgotten. Checklists were “invented” by pilots to reduce the number of accidents, and have been an immense help in that respect. The purpose with a checklist is beautifully summed up by Gawande:
Whether running to the store to buy ingredients for a cake, preparing an airplane for takeoff, or evaluating a sick person in the hospital, if you miss just one key thing, you might as well not have made the effort at all. (page 36)
Why use checklists?
In his profession, Gawande discovered that checklists can also reduce life-saving mistakes during surgery. As he wrote in his book, there is no point in having knowledge if we fail in adapting it in a timely and orderly manner. Failure, he argues, stems not from arrogance, but from not applying what we know works.
We believe this to be equally true for trading. How many mistakes boil down to misuse, system 1 decisions (to refer to Daniel Kahneman), or simply forgetting to do certain steps?
Without checklists, you are prone to skipping or “forgetting” important steps.
Furthermore, checklists are extremely valuable if you want to learn from the feedback loop.