In this chapter we have spent quite a bit of time discussing odds, knowing the odds, as well as how this can benefit us in our speculations. But now it is time to discuss what odds, and actuarial tables are not. To do so I want to introduce you to Ludwig Von Mises. Von Mises was a Austrian Economist who wrote and lectured extensively on Classical Liberalism.
Classical Liberalism advocates political freedom and civil liberties, or the power of the individual, as opposed to authoritarian power dictated by the state. It is rooted in the belief that it is in the common interest that all individuals must be able to secure their own economic self interest, without government direction.
Based on where we stand today as a nation and as a people, it's evident that Austrian Economic Theory has been drowned out by Keynesian philosophy which believes that "private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector". In other words meddling by the Central Banks and Governments to manipulate the price of credit, the demand supply balance, and therefore the behavior of the individual.
So the nanny state is going to help all the people via money printing, currency manipulation and blowing of asset bubbles. In order to facilitate all of this good work, we of course need a army of politicians, bureacrats and bankers to tell us what's good for us. As the power of the State has expanded, and personal liberties eroded, let's see what this has brought our great country.
1 - $21 Trillion in Debt.
2 - $200 Trillion in Unfunded Liabilities, or future promises made that we haven't financed.
3 - Endless War.
4 - Massive expansion of the welfare state which has enslaved it's beneficiaries in a perpetual state of poverty.
5 - 100m Unemployed and Underemployed Americans.
Maybe we oughta try listening to this guy?
If this is considered "helping", I think it's safe to say we have nothing to lose as a nation by trying a different approach. It's clear where 3PC stands on this Philosophical discussion of economics. We believe the proof is in the pudding - and right now that pudding looks, smells, and tastes like shit.
One example: The US government loses billions of dollars a year delivering mail...sticking letters in a mailbox.
While we do not consider ourselves rocket scientists or central planners, we know we could turn around the Post Office's losing ways in a few easy steps.
1) Deliver mail only one day per week, and adjust staffing requirements to meet the new delivery schedule.
2) Phase out taxpayer subsidized pensions and salaries of employees.
3) Charge customers postage costs that ensure your revenues are in excess of your expense.
It's that simple, literally. If the State fails at providing this rudimentary service, how on earth could these central planners possibly be able to manage healthcare, or our retirement, or our economy, or the climate?
The answer is they can't. Via greed and graft they ensure their benefit via a two class system and set of rules whereby they sit on top, and the subjugated populace below them. In his treatise on Economics, titled Human Action, Von Mises discusses this very point.
"It is customary nowadays to speak of social engineering. Like planning, this term is a synonym for dictatorship and totalitarian tyranny. The idea is to treat human beings the same way in which engineers treats the stuff out of which he builds his bridges, roads, and machines. The social engineer's will is to be substituted for the will of the various people he plans to use for the construction of his utopia. Mankind is to be divided into two classes, the almighty dictator on the one hand, and the underlings who are to be reduced to the status of mere pawns in his plans and cogs in his machinery, on the other. If this were feasible, then of course the social engineer would not have to bother about understanding other people's actions. He would be free to to deal with them as technology deals with lumber and iron."
In Human Action, which I highly recommend you get a copy, Von Mises focuses on the action of the individual driving outcomes, and the importance of us understanding the individual and his actions. One topic he expands upon is uncertainty, and it this which we will now focus on.
Our Odds Tables are a critical component of our Trading. It tells us how price has behaved under certain circumstances so that we can help to quantify our risk. But is it predictive? To answer this we must understand the difference between Class Probability and Case Probability.
Class Probability as defined by VM is: "We know or assume to know everything about the behavior of a whole class of events, but about a actual singular event we only know that they are elements of this class." So for example, back to our Actuarial tables - Insurance companies may know everything about mortality of a population in question, say white males, or smokers. But when it comes to underwriting their next policy and the life expectancy of that individual, the only thing they know is what population or class that person is a member of. i.e. Male smokers expire 10 years sooner than non smokers. But does this mean a smoker can't outlive his non smoking counterpart?
The answer is obviously he can - Whether genetics, other lifestyle choices, or some revolutionary supplement, it is possible for individual cases to vary widely to what the class statistics ordain to be true. This is why insurance companies or other entities don't insure people on a one off basis. Rather, they look to ensure a whole pool of people so that the statistical data they use to price risk can then hold sway.
Said another way, insurance companies don't make money by using their actuarial tables to price individual policies. Instead, it is their business to insure a large sample size. They are therefore profiting by pooling and distributing risks, not via calculus on probability.
Case probability as defined by VM is: "We know, with regard to a particular event, some of the factors which determine it's outcome; but there are other determining factors about which we know nothing." Further, "Case probability is a particular feature of our dealing with problems of human action. Here any references to frequency is inappropriate, as our statements always deal with unique events which are not members of any class".
What Von Mises is going to great lengths to explain is the difference between knowing the odds of something occurring statistically, vs the behavior of the next individual Case. He warns against men trying to forecast a particular future event based on their knowledge about the behavior of prior similar instances. Yes, they are part of the same class, but the variability of Human Action dictates that the next roll of the dice is unknown. It may or may not behave in accordance to what the odds are telling us, and this is a critical point to understand.
"In the real world acting man is faced with the fact that there are fellow acting men acting on their own behalf as he himself acts. The necessity to adjust his actions to other people's actions make him a speculator for whom success and failure depend on his greater or lesser ability to understand the future. Every investment is a form of speculation. There is in the course of human events no stability and consequently no safety."
When we discuss odds, and the use of our statistical analysis in our trading program, the true value is in helping to quantify our risk, and not in predicting an outcome.
Like the roulette player who concludes from a run of ten red in succession that the probability of the next turn being black is now greater than what it was before the run, he confuses case probability with class probability. This is the Gambler's Fallacy. This is what you must avoid.
The usefullness of any odds tables are only realized over a significant enough sample size or "class". Therefore, it's imperative as a trader that you manage your betting in such a way that you survive the random individual outcomes that comprise a class of results.
Your number one job as a Professional Speculator is therefore to manage your chip stack. With it, you are in the game.
Without it, you are out of the game... Simple as that. Game Over.