Rarely Thankful to Lady Luck

A bias refers to the tendency to hold a partial perspective while refusing alternative points of view. There are many forms of biases that can be attributed to various personal traits or explained within different contexts.

It is very common for people to show bias in everyday life. One of the most interesting forms is accrediting pure luck to skill based on benefiting outcomes. This bias mainly refers to the mistaken belief that if something appears more frequently than it normally does, credit should be given to a person’s skill as opposed to accepting it as a series of random events.

A few years ago, one of my professors at UCLA asked my class to perform an interesting experiment. All students would toss a coin and only the ones who would get heads would proceed to the next round. The winner is simply the person who manages to get only heads until everyone else loses.

As a reminder, the probability of getting heads using a fair coin is 1/2 per toss. That means that the probability of getting heads n times in a row is simply 1/2 ^ n. Of course, as n increases the total probability decreases.

Even though everyone would agree in the beginning of the experiment that getting heads when flipping a coin is a random event, as the rounds would go by and my classmates would go further their perspective was gradually changing and round by round less credit was given to luck and more credit was given to intense coin flipping skills!

This funny experiment clearly demonstrates how easy it is to confuse skill with luck when only getting exposure to a limited number of random trials or competing against a limited number of contestants. The same concept applies in many other activities in life including trading and investing that our blog is mainly focused on.

A lot of times, it is very hard to have a tracking record that is long enough and hence statistically significant in order to conclude if an investor’s generated returns are based on skill or are just the product of pure luck. As with most things in life, the truth could be somewhere in between and even though not generally much appreciated some merit should be given to luck. The question will always be though what portion was skill and what portion was luck. Or does it even matter at the end?

The truth is that we have a hard time to accept that many events in our lives are just random – especially the ones that benefit us – and are putting a lot of effort to explain them somehow and believe that there is something special about the circumstances or our case. After all, people are rarely thankful to lady luck.

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