Revisting Randomness

Recently I have been re-reading Nasim Taleb's excellent "Fooled by Randomness". I find a few thoughts surfacing in my mind.

One, Taleb noted that good investing/trading performance can be due to randomness, even if the methodology is unsound. Consider a population of 10,000 unskilled investors who have a 60% chance to under-perform the market. Then at the end of 5 years, we will observe 102 persons out of this group of 10,000 people who have outperformed the market every year. Thinking of this, I wonder if my out-performance prior to 2008 is due to luck or skill. I do not really know.

Two, "Fooled by Randomness" has two analogies whereby both traders, in the analogies, blow up and one of the main causes is that they buy on the dips. This point leads me thinking about Bill Miller. Bill Miller is an investor who is known for buying more of the stock, especially when the stock goes down and Bill Miller still believes in his reasons for investing in the stock still hold. There are also other value investors who buys on the dips too.

If buying on the dips increases the probability of blowing up, won't value investors who buy on the dips subject themselves to higher risks? Of course, one may argue that market prices are not important from value investing and long term/business investing perspective. However, no matter what, value investors are still subject to the risk that their hypothesis is wrong and the possibility that they are unable to get out before their chosen business/stock crash. And buying on the dips may magnify the risk of blowing up. To cut it short, I can only conclude that while the risk of blowing up for value investor is low, the risk is still there.

That's probably why heavy use of leverage may not be advisable for value investors who buy on the dips.

Maybe the advice I can provide to myself is to reduce the risk of blowing up in my chosen investing method, and like what Bill Rempel said, "Traders should execute their chosen methodology. If they don't have one yet, they should find one."

P.S. I ignore the demarcation between trader and investor in this post in the last paragraph.