How many white swans would you need to see before deciding all swans are white?
All of them is the minimum to establish with certainty that all are white. You might have a very high probability estimate that the next swan you see will be white, but probability says nothing about certainty.
People are easily fooled by seeing more and more white swans. The sighting confirms their candidate hypothesis that all swans are white.
People look for confirmation of their beliefs more readily than they look for contradiction.
Confirmation bias leads us astray
People like to be right and finding information that supports their belief is rewarding. It is not, however, a good way to make money in the stock market. Stock market success works better if you look for information that contradicts your belief.
Losses are a bigger problem than people think. Confirmation bias is loss inducing.
So what? Everyone has losses and it averages out
Maybe true in the very long run, but that is not where we live emotionally. All losses are real and they cause action. Probably misdirected action. After all, in the entire period of gathering information that turned out wrong, we learned little about what could be right.
There is an obvious solution.
Philosopher Karl Popper says to seek falsification, not confirmation.
Popper points out that no scientific theorem can be proven true. It can be true most of the time but we don’t have all the information. We never can because we don’t know what “all” means.
The approach then is rather than adding more and more things that make something look more true we should spend our time trying to find a way to prove it is false. That might be unsettling, but it does reduce the probability of error. Even knowing the range of possible right answers is useful.
A single black swan disproves the theory that all swans are white
Falsification is efficient. Just one example. If we sought such a result we could learn more.
Finding white swans adds nothing to our knowledge. We expect that. Expectation becomes reality if you see it often enough. “Knowing” things that are false, harms.
It is like a child who says they are bad in math. Their results will prove it. A single good mark should disprove their hypothesis but it often does not. We are more wedded to our beliefs than we should be, because that lets us stop thinking.
If you have an investment strategy, and many do not, you should begin to examine evidence that disproves it. Earnings growth matters? Always? What if cash flow is progressively more negative? Technology changes quickly and buying equipment and research can have big cash impacts.
Jeff Bezos understands it. Amazon is organized to have large free cash flow numbers. Much higher than net income. Free cash flow gives you choices, just like in your home budget. Negative cash flow with high income does not.
Anything everyone knows is probably not worth knowing. It certainly is not worth working to maintain the knowledge. Be the first to find how it falsifies and make a fortune on the short side.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772