“We are in the business of making mistakes. The only difference between the winners and the losers is that the winners make small mistakes, while the losers make big mistakes.”
“More than anything else, what differentiates people who live up to their potential from those who don’t is a willingness to look at themselves and others objectively.”
“Its okay to be wrong; it is not okay to stay wrong”
-Old Traders Expression
On Friday mornings, I like to wax philosophical about recent events. There are often instructive lessons to be learned, if only we pay attention to what others are doing correctly — and incorrectly — in the world of investing and trading. I take every opportunity that presents itself to let someone else pay for my tuition in the school of life.
This has been a week of blunders. Whether it is research, trading, market calls, or economics, we have seen some pretty awful judgment exercised.
When it comes to investing mistakes, I like to use a simple, 3 step process* to avoid big mistakes and to keep errors manageable.
Rule #1: Expect to be wrong.
Rule #2: Admit Error
Rule #3: Repair
The first step is simple attitude shift that is designed to remove your ego from the error recognition and repair process.
We know that the best stock pickers in the world are wrong about half the time; we also have learned that four fifths of active fund managers under perform their benchmarks. Almost no economists consistently forecast future GDP, Employment, Interest Rates, etc. — indeed, nearly all get it wrong when they look out more than month or so.
If you recognize the statistical certainty that you will be wrong, it should be much easier to accept any error as a normal part of your life.
When people refuse to admit error, it is because their sense of self-worth is too tied up in their calls. Once the expectation of error becomes built in, you remove the ego altogether.
Admitting error should be part of your regular process. I have found two ways to do this that seem to get good results: 1) Identify the error in a professional capacity to relevant parties. This can be to you, your co-workers and colleagues. 2) Perform regular reviews of your errors with the hope of avoiding them in the future. I do this with my annual mea culpas; Ray Dalio’s Bridgewater hedge fund is notorious for their brutal self-examinations — and they are (arguably) the most successful hedge fund in the world.
What does NOT admitting error look like? It is Apple investors, who double up all the whole way down from $700 to $400. It is the radical financial deregulators like Edward Pinto & Peter Wallison blaming the financial crisis on unrelated bank loans to poor minorities. It is the cacophony of excuses from the Gold community, blaming the 30% drop on central banks, Goldman Sachs, “paper” gold, the shorts and the dollar. My friend Albert Edward’s reiterated call for S&P500 at 450 — with the SPX kissing 1600 — smacks of a classic non-admission of error. His preference is to go down with the ship.
This week’s mother of all refusals to admit mistake has to be Harvard professors Reinhart & Rogoff. Instead of clearly and honestly issuing a mea culpa, they half admitted error, then back-peddled in a stunningly dishonest OpEd in the NYT today. We still don’t know what the real drop-dead line is for debt because they refuse to admit the mistake and try again (please consider peer reviewed publication next time).
Refusal to admit error prevents you from reaching the third step: Repair. If you do not admit the error, how can you fix it? In academia, this affects your reputation. In trading, your P&L is worse off, and in investing, your long-term returns suffer.
What mistakes did you make this week? What have you done about it?
Expect to Be Wrong in the Stock Market (April 5, 2005)
Ray Dalio & the Machinery of Finance (September 15th, 2011)
* If we want to be clever, we can add a fourth step — analyze how and why the error occurred, and consider ways to systemically prevent these in the future. That is a long term business management issue, and is itself worthy of a full post.