Prediction & Probability
It’s 2005, India is going to play Sri Lanka in Nagpur. There’s a satta bazaar (gambler’s market) working round the clock for people to place bets on how much each batsman is going to score. Odds being offered are: 1 to 1 on Sachin, Sehwag or Dhoni making a century. 5 to 1 on Yuvraj or Dravid making a century and 10 to 1 on Irfan Pathan or Agarkar making more than 50 runs. We understand that these odds are probably correct as the probability that Irfan or Agarkar will make a 50 is very low.
Your astrologer friend calls you and tells you that I have read the charts and because of the interplay of Jupiter and Mars, Irfan is destined to make more than 50 runs today. You, a rational being, say bullshit! and you don’t take the bet. Then the unimaginable happens and Irfan comes out at number 3, scores 83 off 70 balls and you rue the day that you bet on Tendulkar instead of Irfan (Tendulkar only scored 93!).
Now imagine that Vladimir had come to Nagpur that day from Russia on a business trip. He was asked by his colleague Amit to join him for a Cricket match. Vladimir has no understanding of Cricket. He overhears you talking to your astrologer friend and bets a truckload on that 10 to 1 bet on Irfan and wins!
The winner is not always right!
Vladimir got paid for being stupid. If he was to take more such bets on Irfan over time, you and I know that he would lose a lot of money while gaining a hard-earned understanding of cricket (He would probably stop the betting when Amit would tell him what an idiot he was to take that bet!). He just got lucky! And that’s a bad plan to have for life.
Yet, we do this all the time with investments. We’ll read analyst reports with price targets and take that as gospel and part away with our money. That’s not to say that analysts are wrong but that we are depending on someone else’s work and not our own understanding. This leads to disastrous consequences for most of us. We invest on Irfans and Agarkars without knowing the ABCs of business. How do we know who are the Tendulkars and Sehwags and who are the Pathans and Agarkars of the Business world?
Well, that’s a question for another article. What we have to understand is that we have to know the probability and not go for the prediction. Even if we make money with the prediction, we are just being lucky idiots, not intelligent investors.
The world works on probability. Yet, the value given to predictions is far higher. We value the economist more than the businessman because the economist is talking predictions. Predictions are cool and charismatic. Probability is crude, takes effort and cannot be easily understood for most events. A businessman deals in probability and it’s the probabilist that takes the cake.
Predictions might work for you, but that’s your luck playing out, not your work. Don’t pull the trigger based on predictions! Always try to estimate the probability.
