Positive outcomes don’t confirm a decision was correct, and negative outcomes don’t confirm it was wrong. When investing, a gain doesn’t mean the investment wasn’t risky. Risk itself is just the probability of loss at the time of the decision, not what the outcome turned out to be. This means people can genuinely just be lucky or unlucky, and results alone tell you nothing about skill.
Since risk is unobservable both before and after the fact, the quantitative models we use to measure it are only as reliable as the judgements and assumptions baked into them. Often this involves extrapolating historical information into the future. They create an illusion of precision around something that resists measurement by nature. The risk assessments are therefore qualitative and forward-looking. They reason about what could go wrong, rather than extrapolating what has already occurred.
Connections
Link Explanation: Second-level thinking is the tool required to build strong qualitative models that are better predictive of the future than quantitative models. By thinking through the second-order implications of current information was can get a feeling for the possible futures that exist, rather than assuming the future will remain the same as the past.
Link Explanation: Quarterly earnings are by-and-large lagging indicators. They only in form us of what has happened. The price of a stock however, is the attempt by the market to synthesize leading indicators - interest rates, credit cycle, demand growth - into a single number.
Reference
🟢 The Most Important Thing Uncommon Sense for the Thoughtful Investor