I wanted to go with “The Most Mind-Blowing Study In Investing,” which, at least from my perspective, would’ve been true. But it would’ve sounded too clickbaity.
I think we’ve all heard or read the thought 1000 times already - but as we are all just smart monkeys playing the game with our memories decaying it is always great to refresh the guiding principles of the value investing religion with yet another regular sermon.
The piece reads nice and smooth, good sermon, preacher.
i think you point about "horizion test" is an important one, and is often overlooked.
i think the right mental model for anyone that is not willing to part with his cash forever, is the following: take the time you'd need the cash back. now imagine that you're buying an option that your thesis is rewarded. imagine that the option has expiry of your desired duration divided by 2. if that makes you feel uncomfortable - you have a horizon issue.
i haven't tested if that 2 factor is optimal, or causes one to reject far too many alternatives.
Really interesting approach. It has the massive advantage of being simple and adaptable for just about anyone, but in my view it requires a certain ability to be honest with yourself (about what you want, what scares you, what you're actually capable of, etc.), and that's probably one of the factors that's most often missing when people try to build an investment strategy (time horizon included).
This looked very promising in the beginning, because I too believe that risk=volatility is oversimplified model. However, it turned out to be very disappointing due to misuse of maths. If you know something for sure this is not a random variable anymore therefore volatility doesn't make sense (i.e. it's 0).
One of the core points of the piece is precisely that reducing something as multifaceted as “risk” to a single mathematical quantity, something we can compute “objectively”, is a category error.
If we take “risk = volatility” as an axiom, then measuring volatility cannot establish that the axiom is correct; it just operationalizes the assumption. In that sense, you can’t refute or validate the axiom from within the same framework, you’ve defined the conclusion into the premise.
For those two reasons, I didn’t use, and couldn’t use, the standard mathematical tools that assume risk equals volatility.
That’s why I used a reductio ad absurdum: syllogisms and basic logic to show that the identification “risk = volatility” leads to contradictions or unintuitive implications in certain edge cases.
Also, even if I know volatility will occur with certainty, that doesn’t mean it ceases to be uncertain in the relevant sense: I may still not know when it will materialize or how large the move will be. The uncertainty is about timing and magnitude, not about whether price variation exists at all.
You can certainly challenge my interpretation of what “risk” should mean, because that part is, unavoidably, partly philosophical. But I don’t think your objection undermines the method I’m using to argue that “risk = volatility” is an inadequate definition.
Practice and theory is a large gap. The human brain is not designed for volitity. Fear/flight is embedded in our psychology. To master that is to master investing.
I would’ve agreed with you 10 years ago, but much less so today.
I’d even say that dealing with noise volatility is a relatively easy problem to solve. Time teaches that lesson quickly, and very explicitly.
Speaking from experience: I’m a highly concentrated investor, mostly in sub-$500M market caps, sometimes even below $10M. I’ve already watched my portfolio drop 20% in a single day without it bothering me. Noise volatility stopped being an issue a long time ago, but it felt very different early on.
What still hurts performance are other, harder problems: distinguishing noise volatility from signal volatility (i.e. the business actually deteriorating), position sizing, timing exits, estimating opportunity cost, and so on.
Clearly, mastering volatility is just a small step toward mastering investing, in my opinion.
Hey, great read as alaways. That line about applied mathematics producing equations that stay close to reality really hit home. So true for many fields, not just finance.
I think the most surprising example I know (at least one that’s somewhat “rigorous”) is the early 20th-century physiologists and psychologists who tried to find an equation for motivation and performance.
They were using variables like heart rate, blood pressure, and so on. At the very least, they were imaginative.
If you have any truly outlandish examples, I’m all ears.
I think we’ve all heard or read the thought 1000 times already - but as we are all just smart monkeys playing the game with our memories decaying it is always great to refresh the guiding principles of the value investing religion with yet another regular sermon.
The piece reads nice and smooth, good sermon, preacher.
I think we’ve all heard or read the thought 1000 times already - but as we are all just smart monkeys playing the game with our memories decaying it is always great to refresh the guiding principles of the value investing religion with yet another regular sermon.
The piece reads nice and smooth, good sermon, preacher.
I think we’ve all heard or read the thought 1000 times already - but as we are all just smart monkeys playing the game with our memories decaying it is always great to refresh the guiding principles of the value investing religion with yet another regular sermon.
The piece reads nice and smooth, good sermon, preacher.
You could do the same at the roulette table. Use a martingale system. Play red or black. Double the bet when you lose, and start again at 1 when you win. For most people it is a winning system, except for the one who lose their whole capital, by doubling too often.
I really enjoyed that! Great insight and food for thought. Thanks for sharing
I’m glad you liked it, I enjoyed writing it too. Thanks for your feedback!
Good Post. You explained it quite well and with simplicity
Thank you for the feedback!
I've always thought this, wouldn't have been able to expound it so cleanly though - thank you.
Thanks, but the heavy lifting is Wesley Gray's study. And what a study!
this should be hanged on the walls. brilliantly written.
Thanks a lot for the feedback, really appreciate that!
Absolutely loved this! A unique angle that hit me right in the nose! For me…… it mattered. Thank You ! 🙏🏼
Thank you so much, genuinely means a lot to hear that!
I think we’ve all heard or read the thought 1000 times already - but as we are all just smart monkeys playing the game with our memories decaying it is always great to refresh the guiding principles of the value investing religion with yet another regular sermon.
The piece reads nice and smooth, good sermon, preacher.
As a fellow monkey, thank you.
Good article and such an important point and examination. Risk isn’t volatility. Indeed, volatility can be an amazing opportunity.
Thanks NBM!
thanks for that.
i think you point about "horizion test" is an important one, and is often overlooked.
i think the right mental model for anyone that is not willing to part with his cash forever, is the following: take the time you'd need the cash back. now imagine that you're buying an option that your thesis is rewarded. imagine that the option has expiry of your desired duration divided by 2. if that makes you feel uncomfortable - you have a horizon issue.
i haven't tested if that 2 factor is optimal, or causes one to reject far too many alternatives.
maybe i should :)
Really interesting approach. It has the massive advantage of being simple and adaptable for just about anyone, but in my view it requires a certain ability to be honest with yourself (about what you want, what scares you, what you're actually capable of, etc.), and that's probably one of the factors that's most often missing when people try to build an investment strategy (time horizon included).
Buy and hold , hold , hold Great companies …. That is the force that keeps volatility at bay .
This looked very promising in the beginning, because I too believe that risk=volatility is oversimplified model. However, it turned out to be very disappointing due to misuse of maths. If you know something for sure this is not a random variable anymore therefore volatility doesn't make sense (i.e. it's 0).
One of the core points of the piece is precisely that reducing something as multifaceted as “risk” to a single mathematical quantity, something we can compute “objectively”, is a category error.
If we take “risk = volatility” as an axiom, then measuring volatility cannot establish that the axiom is correct; it just operationalizes the assumption. In that sense, you can’t refute or validate the axiom from within the same framework, you’ve defined the conclusion into the premise.
For those two reasons, I didn’t use, and couldn’t use, the standard mathematical tools that assume risk equals volatility.
That’s why I used a reductio ad absurdum: syllogisms and basic logic to show that the identification “risk = volatility” leads to contradictions or unintuitive implications in certain edge cases.
Also, even if I know volatility will occur with certainty, that doesn’t mean it ceases to be uncertain in the relevant sense: I may still not know when it will materialize or how large the move will be. The uncertainty is about timing and magnitude, not about whether price variation exists at all.
You can certainly challenge my interpretation of what “risk” should mean, because that part is, unavoidably, partly philosophical. But I don’t think your objection undermines the method I’m using to argue that “risk = volatility” is an inadequate definition.
Practice and theory is a large gap. The human brain is not designed for volitity. Fear/flight is embedded in our psychology. To master that is to master investing.
I would’ve agreed with you 10 years ago, but much less so today.
I’d even say that dealing with noise volatility is a relatively easy problem to solve. Time teaches that lesson quickly, and very explicitly.
Speaking from experience: I’m a highly concentrated investor, mostly in sub-$500M market caps, sometimes even below $10M. I’ve already watched my portfolio drop 20% in a single day without it bothering me. Noise volatility stopped being an issue a long time ago, but it felt very different early on.
What still hurts performance are other, harder problems: distinguishing noise volatility from signal volatility (i.e. the business actually deteriorating), position sizing, timing exits, estimating opportunity cost, and so on.
Clearly, mastering volatility is just a small step toward mastering investing, in my opinion.
Hey, great read as alaways. That line about applied mathematics producing equations that stay close to reality really hit home. So true for many fields, not just finance.
Thanks for your feedback!
I think the most surprising example I know (at least one that’s somewhat “rigorous”) is the early 20th-century physiologists and psychologists who tried to find an equation for motivation and performance.
They were using variables like heart rate, blood pressure, and so on. At the very least, they were imaginative.
If you have any truly outlandish examples, I’m all ears.
I think we’ve all heard or read the thought 1000 times already - but as we are all just smart monkeys playing the game with our memories decaying it is always great to refresh the guiding principles of the value investing religion with yet another regular sermon.
The piece reads nice and smooth, good sermon, preacher.
I think we’ve all heard or read the thought 1000 times already - but as we are all just smart monkeys playing the game with our memories decaying it is always great to refresh the guiding principles of the value investing religion with yet another regular sermon.
The piece reads nice and smooth, good sermon, preacher.
I think we’ve all heard or read the thought 1000 times already - but as we are all just smart monkeys playing the game with our memories decaying it is always great to refresh the guiding principles of the value investing religion with yet another regular sermon.
The piece reads nice and smooth, good sermon, preacher.
You could do the same at the roulette table. Use a martingale system. Play red or black. Double the bet when you lose, and start again at 1 when you win. For most people it is a winning system, except for the one who lose their whole capital, by doubling too often.
I honestly don’t see the connection between anything in my post and a martingale. A bit more detail would be appreciated.