Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Sunday, 23 June 2013

Fortuitous circumstance and the appearance of skill

The current travails of gold and silver obliquely remind me of experiences I had in my previous life as a sell-side trader. This is because of the incredibly fortuitous timing of my January article in LiveMint. Back then, I'd written a piece advising dumping gold and silver (Gold and Silver: A Wealth Hazard). It was published on 25th January when Gold was at $1660 and silver was at $31.56. Since then both have continued to sell-off. By 1st March gold had declined to $1582 and silver to $28.01. Then came the famous crash in mid-April when gold closed at $1380 and silver at $23.47. The subsequent dead-cat-bounce unwound in May as both continued their downward journey to end up currently at $1295 and $19.87(1).

This is a "guru-dom" establishing result because in markets nothing succeeds like a successful prediction. On the rare occasions when a forecast is proved right almost immediately, it gives the appearance of extreme perspicacity on part of the forecaster. As a result, pure luck is mistaken for skill. There were plenty of traders blindly swinging the bat and connecting to reach superstardom and a series of guaranteed bonuses until the inevitable miss.

The emphasis on one-off results is a little strange not least because it suffers from a small sample size. There is always a guaranteed winner in a coin-toss (which is a fair approximation of zero-sum financial bets since the P&L evaluation period is short - an year maximum even for instruments which mature 30 or more years later). Correctly predicting one or even a few such tosses does not imply skill. Instead true skill is determined by the analysis behind the prediction rather than the immediate success/failure of the prediction itself. Even astute traders/investors get it wrong fairly often but over time sound analysis is going to produce more successful forecasts than pure chance. Moreover, successful traders/investors overlay it with the ability to determine and limit the downside in case the prediction takes time to come good or fails completely.

But I'm quite pleased with this fluke and if such a run of luck continues I might end up as a celebrated market pundit opining on TV and make a fortune selling books and periodicals.  

(1) All prices from FT data archive

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