Black Swans and Belief on Own Terms

There exists a line between independent thinking and believing things on your own terms. If we form a distribution for what may happen in the future, and there is a shock to our distribution upon data collection, we can refuse to update, which shows we are more convinced of our own models than reality. However, the presence of black swans tells us when reality intrudes on a model, we have to update our beliefs, or in other words, we have to remember our models are based on a subset of reality not all reality. Everything inside our heads is based on a subset of all that we will see in the future. It isn’t just about updating but about not being so confident in our models in the face of reality. In the 2008 financial crisis, the verdict was we were hit by black swans in that rare events were poorly modeled because people were believing things on their own terms end thus refusing to adapt their models to reality.

When things are poorly understood, an authority is one means of agreeing to coordinate activity but the authority could easily be wrong. When we say we believe things on their own terms, we say we ignore the authority usually like a patient ignoring a doctor despite the doctor having seen many more patients than the patient. Even if the authority may be wrong, and even if we may sometimes ignore the authority, we cannot ignore the authority for reason of wanting to hold onto our beliefs despite reality. The references to Catholicism are such that religions are often equipped to deal with black swans when science and engineering isn’t: tail events are well answered by religion in the face of calamities but science does not provide answers. But we don’t give up on science.

For example, some people like to act on their perceptions. But perceptions may come from outside of yourself. Your perceptions when full may be different from when you are hungry. By acting on their perceptions, independent of authority, they are independent thinkers, but if authority gives a warning and it is ignored, that is failing to model black swans. It’s the same principle that it’s more acceptable to protest against the king than it is the police, as when police talk to you, that is an indication already that you’ve done something wrong and you ignore the police at your peril. Protesting against the king can be understood religiously in the context of divine right to the monarchy and what the king does is less of an indication to where you may have gone wrong. The king isn’t as much a source of reality as a policeman individually making an arrest. But rather the king makes decisions for you so you can buckle the authority with independent thinking on your own. What about in the family? Figures in the family are much more akin to reality than to a benevolent guidance. But ultimately, ignoring authority is done at your peril in any situation.

The traders around 2008 were all about going against the grain and buckling authoritative statements about the economy, sometimes using them as negative indicators. Of course that climate couldn’t last and it only developed from innovations in financial engineering.

After 2008, some of the traders went into tech and did well for themselves. Others like me kept on going at the same problems. One such problem is computer science and whether we can harness artificial intelligence or whether it will end up controlling us. This question had been posed to influential figures in Silicon Valley. That is indeed what is coming next as high frequency machine trading took over large niches in the market following 2008. Much of the scalping type of trading became nonproductive–well maybe they still make money but they are not driving events in the market–with the advent of machines, and my general philosophy is unless you can outsmart a machine at chess which you can’t, you should stay out of short term choppiness in the markets as even if you make money, you will lose more of your mind.

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