Survivorship Bias: Why "Good" Traders Are Lucky Rather Than Skilled

in uncertainty •  10 months ago

We don't call lottery winners talented, we call them lucky. So why then do we attribute so much skill to day trading? Investing is a strategy, timing market swings is gambling. With more people playing money than ever, I would like to inform those who are willing to listen that these people aren't gifted, their success is accidental. I would also like to point out that there is no such thing as certainty and one shouldn't bet on it.


"How do you keep rolling high numbers?"
"It's all in the wrist technique!"

What is survivorship bias? It's the attributing of one's success to talent or decision making rather than overlooking the fact that such "survivors" are expected to survive just based on the sheer number that exist. Let's suppose that trading is completely random. We would expect a small number of people to be successful in spite of their decisions. Given a large enough sample of people, you expect to find outliers. The bias or fallacy here is that people ignore the randomness and attribute their success to themselves. How wonderful.

I mentioned in previous posts that success is hard work plus luck. Why? Someone who wins the lottery is successful. Someone who does 100 plus hour work weeks in a failing business is not. We can all acknowledge that winning the lottery takes no real talent or skill. Most of us understand basic probability. But we seem to throw the logic out of the window when we aren't playing a rigged game and the perception of skill is in play.

People view the markets as a game of skill rather than a random mess. I will clarify this: I do not believe the markets are entirely random. But playing the market is like playing several rounds of rock-paper-scissors. If you understand human tendencies and understand your opponent you can win more frequently than you lose. But nobody wins these games 90% of time except the very few, because they are lucky.


An accurate representation of playing the market

So, why care about survivorship bias? Well it helps you to make certain decisions and understand how those decisions fit in to the chaos and randomness that permeate our lives. There are some of you that trade in cryptocurrency. You can still make smart decisions in the context of uncertainty. But you shouldn't be listening to those people saying "Listen to me, I made lots of money using this strategy, it works."

There are two very good reasons you should never take this advice at face value:

  1. If the strategy worked 100%, everyone would use the strategy. But then, since everyone is using that strategy, it doesn't work.

  2. If we consider survivorship bias, it is likely that this person has benefited from quite a good amount of luck.

Next, as smart as I might pretend to be sometimes, I'm very lucky as a cryptocurrency investor. Reasons I'm a lucky survivor rather than a skilled investor:

  1. I first invested in Bitcoin at $2200 at the end of May 2017. The price increased 5 fold in less than a year. Someone who invested in 2014 did not experience such an increase.

  2. In terms of disasters, the waters have been relatively calm since May 2017. If people actually knew how risky their investment was, it wouldn't be nowhere near $10,000. We are just waiting for a catastrophic event to produce a significant pullback in the market.

  3. Bitcoin's popularity has exploded in the past year. Nobody could have predicted the exact timing. Those that did are very good observers of trends and are also lucky.

Now I'm not a blind gambler. I follow trends, news and rumors to stay informed and understand what people are thinking at a certain given moment. But I don't know where the markets are going. So I like to hedge bets that I make. That way I can win both ways and am somewhat protected from large market swings in either direction. People who invest their entire live savings into crypto are incredibly stupid. Although they are very brave and you can view this activity as courageous, it completely ignores uncertainly.

One last point to illustrate survivorship bias, is to take a look at the Top 20 coins now. In five years how many of those will still be there? How many will be profitable (from fiat perspective)? How many will be basically dead? Certainly the Top 20 will change. Which means some coins are going to be losers. How can you with any certainly pick those that will stay in the Top 20?

But Bitcoin and Ethereum will still be there, right? What if faulty code brings down the network? What if a nuclear war starts? What if governments start banning holding coins? What if banks trick people into owning fiatcoins? What if a massive solar flare hits the Earth and knocks out part of the power grid? What if quantum computing becomes mainstream faster than expected?

Certainty is imaginary. There's a reason for insurance. Because although catastrophic events are rare, not everyone can survive them. Although there will be some schmuck that tells you the strategy he used to survive these events and will tell you how skilled and talented he is. Unfortunately people like that are often losers in future disasters because their luck simply runs out.

For those interested in randomness in markets and how we suck at understanding it, I recommend reading the book Fooled By Randomness by Nassim Taleb. It really does give you another perspective of the markets which might be helpful in this quickly growing market that tends to look bubbly at times.


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This also applies to poker players. Having good poker skills help but sometimes you get destroyed by bad luck even though you have made good "plays". There is the other case where "bad plays" (low percentage of winning type of moves) get rewarded by good luck.

Certainty is imaginary. There's a reason for insurance. Because although catastrophic events are rare, not everyone can survive them.

These rare events have huge impact. There are financial models out there that focus on Value At Risk. That is a probability and finance topic that I am somewhat familiar with.


Those models (VAR) help but they are fragile to the never before seen event. The problem with statistics and probability is that we can never have 100% confidence in anything. But at least some people are being conservative with how they bet and looking at expected values rather than perceived values. Which is better than nothing.