here are some basic ideas to guide The Idler in the terrain of investments. These ideas belong to the world of tinkering rather than to the realm of grand philosophical principles.
idea 1: the terrain is unstable and wild
(see "on sampling and its discontents")
If the terrain is unstable and wild, slicing data chunks from the past to understand what’s going on in the present comes with serious limitations (as there will be no reliable convergence in mean, covariance, etc.) and an unwarranted confidence that will be granted by these statistical approximations.
In addition, it follows that the practice of forecasting (or relying on your favorite strategist’s projections) is trivial at best. The forecast will not only miss the mark, but it may miss by orders of magnitude.
idea 2: given Idea 1, one must know when risk and uncertainty do not overlap
Starting with the definitions: risk refers to situations where outcomes are unknown but their probability distribution is known or knowable. Uncertainty (sometimes called “Knightian uncertainty”) describes situations where the distribution itself is unknown or unknowable.
Risk can be quantified and therefore hedged or insured. Uncertainty escapes this as one lacks the knowledge to assign probabilities in the first place.
idea 3: given Ideas 1 and 2, mispricing is unavoidable
Risk will at times be mispriced. Uncertainty will often be mistaken for risk.
The inevitable is market inefficiency, or the latent opportunity for one to earn “alpha” or destroy (lots of) value.
idea 4: to play the game, one must be alive first
The wild nature of the terrain and uncertainty makes bankruptcy (i.e., blowing up) a real possibility. More real than most of us think.
Therefore staying alive comes before anything else. There’s nothing worse (hyperbole permitted) than asking the casino for a ride home at 4am on a Tuesday.
idea 5: to ensure survival, position sizing is fundamental
One way to avoid the free ride at 4am (post losing it all at the craps table) is to not play the game. Another is to place position sizing at the forefront of every decision. This goes for existing as well as for prospective investments.
That is it. We want to stay in the game to enjoy it and perhaps “win” it.