Investing and Probabilistic ThinkingBack to home
I’ve been learning more about successful investors. I want to know what led to their outsize success and why they’re able to repeat it. One common trait I’ve noticed is probabilistic thinking.
Most people are binary thinkers. They think only in terms of an outcome 100% happening or not happening. But binary thinking doesn’t reflect the reality of the world. Most outcomes aren’t 100% guaranteed because the world is full of randomness and uncertainty. There is usually more than one possible outcome, each with a probability of happening (even if it’s small).
These investors understand this and factor probabilities into their decision-making. Outsize returns usually result from betting on non-consensus outcomes that have a probability and return profile the investors like. For example, when the prices of assets are falling continually, most people think to sell to avoid further losses. These investors will buy (non-consensus) if the probability of these assets rising is higher than them falling further and the return could be outsize.
They also understand that probabilities and outcomes are different. The probabilities of an outcome can be on your side, but that doesn’t ensure a favorable outcome. Randomness and other factors are still present. When your desired outcome doesn’t happen, that isn’t a reflection on the quality of the decision. It just means the probabilities didn’t work out in your favor this time.