Luck or Skill

by ALVIN on NOVEMBER 24, 2012

I am typing this post while holidaying in Osaka. Few days ago, my girlfriend and I was supposed to travel to Kyoto and spend a night in a temple. As it was autumn, the sun set pretty early at around 4pm. We navigated in the dark and Google map pointed us to a temple which was closed. In fact, many temples were closed. We were pretty lost and wondered if we would ever get to the right temple. My girlfriend tried asking passer-bys for directions. Most did not know about the temple although they were trying to be helpful. Just as I suggest we put up a place in a hotel nearby, my girlfriend tried asking another passer-by. We were lucky to meet an English speaking Japanese and who seemed to be familiar with the area (his friend dressed as a monk). They walked us to the temple and we managed to check-in that night. On hindsight, we discovered that Google map pointed us to a wrong temple. Luck has helped us find our place of stay. It was not our skill in the Japanese language or excellent understanding about the area which got us where we wanted to go. Also, we became lucky because of my girlfriend’s perseverance.

Since I was a child, I was taught that success is a result of hard work.  I was told that studies was important and my job as a school goer was to put in enough effort and get good grades. A good educational qualification is a gateway to a good paying job and a “successful” life. It isn’t wrong to think this way as a graduate does have access to certain jobs that a non-graduate does not. But most of us who went through the educational system and transited into working life know that academic qualifications do not guarantee you a future. The differences in skills among others and myself are minimal – my colleagues are able to do most of the things I do and vice versa. The main difference between those who promote faster and those who do not is about opportunities. It is likely the former was presented the opportunities and they managed to perform well. This opportunities become reasons for their promotions. Those who are successful and rich will tell you how hard they worked and how skillful they are. But they will not equally acknowledge the role of opportunities in contribution to their success. Humans have funny biases - We often attribute success to our own skills and failure is a result of bad luck.

(Malcolm Gladwell touched on opportunities extensively in his book, Outliers. He mentioned about two high IQs individuals, Chris Langan and Robert Oppenheimer. The latter was a more successful individual because of the backing of his wealthy family and his good social skills. The IQ was not a crucial determinant for success. You can read more about it in this book summary)

Jon and I discussed about the role of luck in successes. Interestingly, we observe the role of luck in one of our breakfast outings at a popular curry rice stall in Tiong Bahru. We both concurred that the dishes were mediocre but we witnessed many people willingly queue for the food. In terms of skill, the cook is not of Michelin standard. In terms of profitability, I bet there is a decent amount of income. We believe the stall owner was at the right place, at the right time, and serving the right crowd.

Stock picking involves a lot of luck. Jon would argue with you that if Warren Buffett was in Japan, he would not have done well during the lost decade with his basket of carefully selected Japanese stocks. Being at the right country does make a big difference to your success.

No matter what method you adopt to buy and sell in the market, you cannot ignore the role of luck in investing. We can only evaluate stocks based on historical performance (applies to both Fundamental and Technical Analysis). The future always remains unknown and full of possibilities. We tend to find patterns and reasons why a stock should outperform in the short term (trader) and in the long term (investor) based on observations of past data. We place out ‘bets’ for the future and find comfort after we have done our due dilligence. We believed we deserved to be rewarded for our skill. Like it or not, we cannot control the outcome. Jon and I wrote about control in our previous posts here and here.

To invest successfully, you either

• position yourself with the odds in your favour, or
• limit the role of luck

I do not have a clearly defined solution for the first bullet. If you trade or invest with a set of rules or a system, you can calculate the expectancy of your trading strategy. If you are a discretionary trader or investor, it will be harder to calculate your edge. You may have to evaluate which selection criteria is attributed to your skill (something within your control) and which is attributed to luck (something not within your control). For those criteria relying on luck, you must accept the possibilities that luck will turn her back against you and how you are able to handle it. The good news is that if you are right, you will earn a fortune (provided you put a significant amount of stake). You can read more about randomness in the post on Drunkard’s Walk and Fooled by Randomness (we are doing injustice to this great book by Nassim Taleb with a rather short summary. We will expand the post soon).

For limiting the role of luck, you can choose something safer with less volatility. A permanent portfolio and a life insurance policy are some apt examples. They compensate the lack of huge gains with certainty and less dependency on luck. One important point is that there is no way you can eliminate luck totally. Insurance companies and banks can collapse even though the investments you hold appear safe for now.

To end it off, I would like to talk about the role of perseverence – Perseverence may increase your exposure to luck. Just like the first story I shared in this post, my girlfriend’s perseverence in asking passer-bys for directions made us lucky. Salesmen who can handle rejections and carry on selling is more likely to succeed as compared to those who do not. Employees who are more eager to accept challenging tasks have higher chances of outperforming their peers. Investors/traders who learn about themselves and the markets have higher chances of becoming profitable.