Good news: I have been busy writing a book about Hands-On Retail Investing. It will still take a while to finish and in the meantime I will post select chapters on investment & trading ideas, philosophy, strategies, hacks, and much more here. Feedback is welcome: You can contact me and leave a note or comment, if you are interested in an advance copy of the book – I plan to give out a limited number for free!

Find Your Own Way

This blog is for people like myself! Individual investors, who love the idea of getting their hands dirty to to take control of their own investment and trading journey. Managing to overcome major obstacles on the path to becoming a successful investor or trader depends a lot on finding an approach that fits your personal mentality and skillset.

However, many basic concepts are universally applicable. There are tools to build a solid investment framework into which diverse ideas, strategies and asset allocations can be fitted according to each investor’s individual preferences and expertise. To avoid a chaotic salad of individual stocks, haphazard funds, or random collections of strategies that so many portfolios end up looking like, everything I do is part of a framework – a top-down, big-picture approach into which each bottom-up idea or strategy fits like a glove.

Even if you run only a single strategy, for example purely specialize in selecting stocks or execute stand-alone trades in sequence, a portfolio allocation framework is the fundamental basis of risk management: To allocate an optimal amount of risk across active positions and balance this with a cash reserve or a prudent amount of leverage that avoids a blow-up of your portfolio in worst case scenarios.

The key to investment success is to find and build on your strengths, as well as to recognize your weaknesses. Often it is more realistic to find ways to introduce friction to reduce unwanted behavior (by having a plan), rather than try to force improvement on areas that you are simply not suited for – the energy is better spent doubling down on where your skills already lie.

The Investment Puzzle

Crawling the web for ways to learn about investing, you end up with a pile of great books and resources that are all worth reading. But, they usually are individual parts of the puzzle and rarely are these pieces brought together to form a big picture. Without a clear framework to place these puzzle pieces into, this can do more harm than good, because it leads to constant strategy hopping and a chaotic portfolio. No strategy works all the time and conviction is needed to power through the rough patches. It is essential to make the approaches you use your own, so that you can stick with them. Myself, I have never met a well-presented strategy that I didn’t like, but just a very small handful turned out to be actually useful.

Over the next months, I will highlight basic concepts to help think constructively about trading and investing, as well as describe practical approaches for building a personal trading framework. A lot can be gained by screening out useless noise to concentrate on what matters most, and for that one needs to develop a mindset that can deal with an environment that is characterized by uncertainty – so that is where I will start today.

Probabilistic Thinking

In financial markets essentially anything can happen at any time – they are the very definition of uncertainty. Beware of FURUs (fake trading gurus) with cemented opinions arguing that they are 100% right about the market. It is mind-blowing just how many financial discussions revolve around such a completely useless mindset, which will most definitely not lead to long-term trading success – absolute conviction invariably leads to unsustainable losses when it turns out to be wrong.

In a probabilistic world there is no right or wrong, there are only outcomes that were more or less probable. At any point in time a wide distribution of outcomes is possible and nobody can predict any one result with certainty. We always have to incorporate this in our plan when aiming for winners to mitigate the risks.

Because the human mind has a hard time to consider events as probabilistic (in hindsight they always seem to have been pre-determined), it is essential for developing a good investment process to separate the inherent likelihood of an event to happen at the outset from the actual outcome. This is especially relevant in an environment in which the assessment of probabilities itself faces great challenges and uncertainties – financial markets in contrast to games of chance are a perfect example.

A correct probability assessment for a certain event to occur with a 70% chance makes a positive outcome likely, but never certain. Quite the opposite, by definition a correct assessment implies that 3 out of 10 results should be contrary to the prediction. This is not the same as a wrong forecast, but simply means that the less likely outcome occurred as must happen from time to time. Only over a large sample size of a distribution of different outcomes can we become increasingly sure whether they are aligned with a probabilistic forecast.

A roughly 70% probability is the historical chance for a positive return for the US stock market in any 12-month period, the base rate of positive stock returns: For every 7 winning years we had to endure 3 losing periods on average, which are excellent odds in the world of finance.

Annie Duke termed the common tendency towards hindsight bias as “resulting” in her excellent book Thinking in Bets: We wrongly tend to evaluate the quality of a decision by its outcome rather than by its inherent probability. But a losing trade or investment was not a bad decision, if the ex-ante chance for a win was favorable (assuming equal sized wins and losses for the moment). In fact, losses should be happening in proportion to correctly estimated probabilities, anything else is purely good or bad luck. Active reflection is necessary to view an actual result as an inherently probabilistic event, because something else could have easily happened instead.

Thinking about the world as a wide distribution of possible outcomes with different probabilities is an essential tool to help you stay on top of the trading game. Pretending that predictions are certain is purely about ego and has zero benefits to successful trading – quite the opposite.

Good luck with your trading, and thank you for reading!

David

This is not financial advice.
These are my own views, as I may implement them in my own portfolio.
Please do your own due diligence!

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