Killarney

<p>By Michael O&rsquo;Connor, theislandinvestor.com</p>
<h3>I am someone who wants to see all the information before making a decision.</h3>
<p>This is a debilitating character flaw in a profession where every decision is based on limited information and unknowable future outcomes.</p>
<p> When I first started investing, I wanted all the answers before placing a trade. I wanted certainty. As a result, I missed out on countless opportunities.</p>
<p> Over the years, I have worked hard to overcome this. One of the first steps was accepting that investing is a game of probability, not certainty.</p>
<p> People say investing is like chess, but in chess, all information is known and there is a right and wrong way forward at any point. It&#8217;s based on computation.</p>
<p> Investing is more like poker. Both are games of incomplete information. Your success over the long run will come down to your ability to make the best possible decisions based on the available information.</p>
<h3>Flaws in our decision-making process</h3>
<p>With this in mind, let&rsquo;s focus on one of the most common flaws in our decision making process &ndash; resulting.<br /> This refers to our tendency to use the outcome of a decision to determine whether or not we have made the right choice. But there are a number of issues with this.</p>
<p> Bad decisions have &#8216;good&#8217; outcomes all the time. Imagine you&#8217;re late for work and approaching a crossroads as the traffic light turns red. You decide to run the light. You get through just fine and make it to work on time.<br /> Was that the right decision?<br /> The outcome was favourable, but you risked potential death to shave two minutes off your commute. A questionable decision at best.</p>
<h3>Reinforcing bad behaviour</h3>
<p>Previously successful outcomes convince you that it is a good decision.<br /> Sticking with the driving analogies. Imagine you decide to drive home after a few drinks. You get home just fine. So you do it again and again. The successful outcomes compound to the point where you convince yourself this is a perfectly safe thing to do. You become more and more reckless until, eventually, disaster strikes.</p>
<p> Just because the probability of a negative outcome (getting caught, crashing) is low doesn&#8217;t mean the risk/reward payoff makes sense.</p>
<p> We see this in investing all the time. Traders make statistically questionable decisions that work out in their favour. The initial positive results reinforce the risk-taking behaviour until they eventually get blown up.<br /> Bad decisions can play out in your favour for a long time, but eventually, the statistical probability will catch up with you.</p>
<h3>The Element of luck</h3>
<p>In poker, you can play a hand perfectly and still lose because there&#8217;s this luck element to it. Most decisions in life work the same way.</p>
<p> Ignoring the impact of luck means we convince ourselves that we made the wrong decisions when in reality, the decision was correct; we were just unlucky, or vice versa.</p>
<p> Imagine you have a trick coin that is heavier on one side, so it comes up &#8216;heads&#8217; 90% of the time. If you place a bet with someone and the coin comes up with &#8216;tails&#8217;, was that a bad bet? No, you were just &#8216;unlucky&#8217;. Every decision is based on probability, but the probability won&#8217;t always work in your favour.</p>
<p> A 90% chance you will win is still a 10% chance you will lose. Losing doesn&#8217;t automatically make it a bad decision.</p>
<h3>Focus on the process</h3>
<p>When investing, we need to focus on the decision-making process, not the outcome. You want to select the options with the highest likelihood of a positive result. But even if you do this, you can still lose. Not every investment will be a winner.</p>
<p> But if you keep making well-thought-out decisions based on a process that is true to your criteria, these decisions will compound and work in your favour over time.</p>
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