Wednesday, October 31, 2007

Driving & Investing Part II

I've previously written about this before, but it occurred to me recently, as I was weaving through traffic in Washington, DC, that I should elaborate on the similarities between good driving and good investing/trading. I've been working on this one, on and off, for months.

The key idea is probabilities.

Every maneuver I make, every lane change, everything is based on the probability of that maneuver benefiting me. Often (I would estimate 60 - 70% of the time), it does. The remainder of the time -- well, that's just the cost of doing business.

For example, we've got 4 lanes of road with 2 lanes in each direction. If I'm in the left lane with 5 people in front of me, there is at least a 1 in 5 chance (20%) chance that one of those people is turning left and will end up blocking the lane. That sucks. So I start looking for the tells - the brake lights, slowing traffic, people merging out to the right - that indicate that the probability has occurred or is occurring. Now, since I only have 2 lanes to work with, I have to also watch the right lane. The idea is that the right lane could have problems too, but are they as severe as the left lane's? If the right lane has a bus in it with an upcoming stop, there is a good chance (which I have no idea how to calculate) that the bus will stop. So now I am looking at the oncoming traffic, because if there is little or none, that guy turning left has a good chance of making his turn with little impact to me. Also, I'm looking for how much room that bus has to get out of the way (a shoulder or bus lane) giving me and others enough room to get around him when he stops.

Basically, I'm constantly calculating the probability of an event which impedes my forward progress. (Funny, just as I had started working on this piece again a few months ago, I noticed this post over at Accrued Interest. He then followed it up with this one which has more good stuff.) It all comes down to the probabilities of a given event occurring.

The markets generate enough data to make somewhat better (more accurate) predictions, but nothing is EVER identical so we have to discern patterns from the data to help estimate probabilities of various outcomes. It can be done, even on an ad hoc basis, I think, much like navigating road traffic.

I'll have more on this topic in the future, and I plan to get into specific scenarios and their "market equivalents". I need to start thinking like a trader in my trading; I already do it in my driving.

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