Saturday Serendipity
Quote, Mental Model, Interesting find.
Hello!
Reading time: About 4 minutes
Quote
“Compete with yourself and root for everybody else.” ~ Candice Millard
Mental Model
Probabilistic thinking
Probabilistic thinking is when we use simple math and logic to analyse which outcome is better/more likely to occur. It is one of the best tools to have. But the question is in a world which is so complex how difficult is it to navigate the factors and predict. I am not a fan of predicting the future but at the same time you know what has broadly worked and what has not. Simply do those things. Probabilistic thinking helps us navigate this complex world.
“We know now that the future is inherently unpredictable because not all variables can be known and even the smallest error imaginable in our data very quickly throws off our predictions.” Farnam Street
Let’s do a very simple thought experiment,
What do you think is more likely, you getting attacked by an animal and dying or you dying by a terrorist attack? (in the USA)
Most people would think a terrorist attack. But research tells us otherwise.
Your chances of dying of an animal attack are 1 in 1.5million whereas the chances of you dying by a terrorist attack is 1 in 3.2 million.
This means that the likelihood of dying from an animal attack is twice as high as the likelihood of dying from a terrorist attack!
Most of the things we see in the news are extreme events. They take our attention away from the reality.
In probabilistic thinking we will cover one of the main concept known as Bayesian thinking/ Base rates.
What is Bayesian thinking?
To put it simply we see prior information as a source of information to encounter new events in a complex world. We should take into account what we already know when we see or encounter something new. This concept was brought up by Thomas Bayes hence the name Bayesian thinking.
Basically to make an informed decision of something new we take into account the prior information that already exists. Statisticians call it base rates. The example I have given above of an animal attacking and the terrorist attack is a great example of base rates.
We have a knack of ignoring base rates. For instance, if there is any terrorist attack that does take place (i hope not) the next day everyone usually would stay at home claiming it is unsafe to go out. A person who uses base rates or thinks probabilistically will actually claim it is safer to go out now as the probability of another terrorist attack happening the next day is very low.
This video is a great guide.
In Sports
I have a very simple example related to cricket when it comes to base rates. Let’s say you face a ball which is a full length ball at the off stump. Now any batsman would see a full length ball and think of driving it. As this actually has the highest likelihood of connecting to the middle of the bat and at the same time get you runs. In this day and age it is important to not forget the basics as you see all players playing aggressive cricketing shots to balls which for a person with lesser skill makes no sense.
The probability of you hitting a scoop to the exact same ball that someone like an Ab de villiers or Maxwell hit is very low.
In Investing
Pulak Prasad in his book spoke about a lot of companies he does not like to invest in. These categories were companies which had a lot of new technology involved, PSE’s, MNC’s, etc. This would mean he would probably miss out on Tesla, Amazon, Gillette, and many other great companies.
Now why does he do this even though there are winners in this area which fit criteria of a good investment which is a great business at a fair valuation?
The answer lies in base rates. He does not invest in these type of companies because most of them fail. He is willing to lose out on these winners as he does not want to run the risk of losing.
Successful people take into account base rates.
This is a great lesson as investors when we look for great businesses. We sometimes fail to account that the industry that they operate in are industries which are just loss making.
Probabilistic thinking is something which can reduce errors for any field or any situation. It has a lot of overlap with the other biases we covered such as availability and survivorship bias.
Interesting find
That’s it!
Enjoy your weekend!