"The Signal and Noise: The Art and Science of Prediction" is a decent book about probabilistic thinking. There are quite a few takeaways for risk-takers and traders and the book did trigger quite a few thoughts, including:
- Be alert to deadly correlation changes in extreme situations (e.g. asset classes moving together, waves of defaults creating domino effect).
- Traders are often alert to the risk of small losses of the type seen in a typical day, death is more likely on the rare extreme day when the monsters emerge from the darkness.
- Risk taking affects the mind, which affects subsequent decisions i.e. you aren't the same person once you have taken the risk, especially if it is a big risk. The act affects the agent.
- Noise can be easily mistaken for signal.
- Garbage in: garbage out, and there's plenty of garbage.
- Trading and other speculations: Do the numbers after the fact disprove the hypothesis, does failure prove randomness wins and the edge is a delusion? Poor risk management can easily mask the findings, making it difficult to know if the trader ever had an edge.
- Risk management: the concern is not the forecast but the risk of the glaring omission or the reckless battle dominated by emotion (examples to fall back on?).
- One man's signal is another man's noise: e.g intraday trader versus long term. A small technical pattern versus a policy shift. A day of rain in the summer.
- The Fuskushima nuclear reactor had been designed to handle a magnitude 8.6 earthquake, in part because some seismologists concluded that anything larger was impossible. Then came Japan's horrible 9.1 magnitude earthquake in March 2011.
- Human beings do not have very many natural defenses. We are not all that fast, and we are not all that strong. We do not have claws or fangs or body armour. We cannot spit venom. And we cannot fly. Instead, we survive by means of our wits. Our minds are quick. We are wired to detect patterns and respond to opportunities and threats without much hesitation.
- We love to predict things - and we aren't very good at it.
- The signal is the truth. The noise is what distracts us from the truth.
- We ignore the risks that are hardest to measure, even when they pose the greatest threats to our well-being.
- Risk, as first articulated by the economist Frank H. Knight in 1921 is something that you can put a price on.
Uncertainty, on the other hand, is risk that is hard to measure. You might have some vague awareness of the demons lurking out there. You might evem be acutely concerned about them. But you have no real idea how many of them there are or when they might strike.
- 'If you're in a market and someone's trying to sell you something which you don't understand ... you should think that they are trying to sell you a lemon.' - George Akerlof speaking to the author.
- When there is an excess of greed in the system, there is a bubble. Where there is an excess of fear, there is a panic.
- The most basic tenet of chaos theory is that a small change in initial conditions - a butterfly flapping its wings in Brazil - can produce large and unexpected divergences in outcomes - a tornado in Texas. This does not mean that the behaviour of the system is random, as the term "chaos" might imply. ...It just means that certain types of systems are very hard to predict.
- The terms 'prediction' and 'forecast' are employed differently in different fields; in some cases, they are interchangeable, but other disciplines differentiate them. No field is more sensitive to the distinction than seismology. If you're speaking with a seismologist:
A prediction is a definite and specific statement about when and where an earthquake will strike: a major earthquake will hit Tokyo, Japan, on June 28.
Whereas a forecast is a probabilistic statement, usually over a longer scale: there is a 60 percent chance of an earthquake in Southern California over the next thirty years.
The USGS's official position is that earthquakes cannot be predicted. They can, however, be predicted.
- 'Efficient market hypothesis has two components', Thaler told me over lunch. ...'One I call the No Free Lunch component, which is that you can't beat the market. Eugene Fama and I mostly agree about this component. The part he doesn't like to talk about is the Price is Right component.'
- (Thomas Schelling) 'There is a tendency to mistake the unfamiliar for the improbable.