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Robyn Williams and David Spiegelhalter Discuss Risk

A nice audio discussion (MP3) about risk. The post at the university held by the professor was funded by trend follower David Harding. Give a listen!

Transcript:

Robyn Williams: So what’s the risk? Last week we spoke to David Spiegelhalter about Paul the octopus and the maths of probability. This week, what’s behind his actual job, Professor of the Public Understanding of Risk at Cambridge?

David Spiegelhalter: Whatever you think about them, this was a hedge fund that paid for this post in Cambridge. It was a very enlightened move, I think. David Harding who runs it, they make a lot of money and they give quite a lot of it away. And so he supports various mathematical charities in particular and he decided to support this post in Cambridge. One of the nice things is that it pays for my salary, and there is absolutely no guidance or pressure whatsoever to work on any particular topics, and the last thing I do is financial work, I have no idea about financial risk. But I do work in many other areas. I come from a background of medical statistics so I concentrate on medical and health issues. But of course with a job title like this you get pulled into all sorts of stuff, so suddenly you find you have to be an expert on volcanic ash and child safety and you have to be an expert on cycle helmets and things like that. So I am desperately trying to learn up about all these issues all at the same time.

Robyn Williams on Risk Management
Robyn Williams, CC Wikimedia

Robyn Williams: In general is the public (and I suppose you’re talking about Britain) more leery about risk, about going out, about just being in the world, than it should be?

David Spiegelhalter: That’s a difficult question. One of the things I often get asked by people with a very strict scientific attitude is to say, well, tell me how hopeless people are at dealing with risk, how irrational they are. And I refuse to follow that line of questioning because you just have to think about yourself, about myself; I am not like a rational human being who weighs up everything mathematically, I’m an emotional person who acts largely by their feelings, and that’s how people have dealt with risks since the beginning of time.

The whole mathematics of risk, of probability and ideas like that, are very recent on the scene, they’ve only been around for a few hundred years and we can’t really think that everyone before that was completely stupid and irrational. I think there were probably some quite wise people around who understood, using their feelings, about what uncertainty meant and how to deal with it. We have to deal with uncertainty in our lives all the time.

So saying, I think you could say that there has been in this country (and I’m sure in many other places) far too much of a concentration on trying to say, well, something bad has happened, we’ve got to stop it ever happening again. And this of course is nonsense. Things will always happen, bad things will happen, but there comes a point when actually it’s not worth doing any more because the harms of trying to reduce that risk might easily outweigh the benefits. And the natural area of this of course is in terms of child safety. There comes a point where we must say that we can’t protect our children from everything bad that might happen to them, and sadly this means that on occasions, very rarely, a bad thing will happen to a child.

On the other side of that of course is that if you do try to protect them too much, what other harms are you doing to them in terms of reducing their feeling of adventure, the possibility of learning from failures, of essentially being able to pick themselves up and start again when things go wrong? We can’t protect people and actually it’s not doing them any good to try to protect them too much.

Robyn Williams: Have you crunched the numbers on various aspects of a young child’s life, like walking to school or playing sports where they might get a tonk on the head?

David Spiegelhalter: I haven’t done the sports stuff. One of the difficulties of course is just the data on injuries, for example, it’s ropey because there is no standard way of reporting these things. Sadly of course we can count the bodies because the one thing that is recorded is deaths, and we can look at those statistics. I looked at some recently because of some issues that came up in this country on a father who was being threatened with being reported to social workers because he was allowing his daughter to walk 20 yards to catch a school bus and crossing a road. So here was a seven-year-old girl…it’s extraordinary, seven-year-old children are unbelievably safe, they’ve never been safer. I mean, it’s sad, but something bad will happen to some of them; one in 12,000 seven-year-old girls will die before they’re eight, of all causes. But that means all causes, of illnesses and everything else. If we look at, for example, kids being knocked down, pedestrians, in this country, England and Wales, 50 million people, 1.5 million girls between the age of five and nine, in 2008 one was killed on the roads as a pedestrian. That’s a terrible tragedy, and it was quite a lucky year, and boys have twice the risk of girls, that’s well established…

Robyn Williams: That’s still only two.

David Spiegelhalter: Yes, normally there are a bit more than one, normally it is more than one, it’s just to show that out of 1.5 million, it’s a very small number. So it comes to a point when obviously these are tragedies but things will happen, and surely it’s really important to encourage children to be out and about, to be roaming, to have a life of freedom et cetera.

Robyn Williams: What happened to the father who let his kid go 20 yards to the bus? Was that okay?

David Spiegelhalter: I think the council relented rather. People are fearful, there is a fear of litigation that if something happens somebody is to blame, and schools are very cautious about school trips, and this sets up a very pernicious environment which can just lead to a lack of adventure, lack of risk. The trouble is risk, it’s got bad press, the word ‘risk’ but there are such things as good risks. We take risks. Maybe a better phrase would be that we take ‘chances’, that’s got a better connotation of the fact that taking a chance because something good might happen, we might fail, it might not work, so maybe we should be thinking of risk assessments as chance assessments so we can really think of the fact that when we are uncertain about what might happen, that includes the fact that something good might happen as well as something bad might happen.

Robyn Williams: I suppose one of the terrible things, looking at that, is the sheer cost. You mentioned litigation, of all the former filling-in to see whether someone can get the permission to go out on a school hike or go to places where there might be a cliff-top or, one of the Australian examples, a colleague of mine had to fill in a form which went through five layers of management because there might have been snakes in a suburb of Sydney. I mean, you can get snakes anywhere in Australia but the chances are unbelievably remote, and the snakes are probably hiding. But the cost of litigation and the cost of bureaucracy, has it gone out of control?

David Spiegelhalter: What’s very interesting is that this new government in our country just yesterday has announced that they are going to have a war on unnecessary health and safety bureaucracy, and they’ve got a report that has been written, and they’re hoping to dismantle much of this and to try to stop litigation in these circumstances as well. So things are on the move here, there is a process of change that is going on that’s supported by the government, it’s going to be very interesting to see what happens.

Robyn Williams: So far you’ve mentioned how life is safer than many of us perceive. What about where there are risks that we are rather too blithe about?

David Spiegelhalter: The trouble is the risks we are all so aware of are the horrible things that are going to kill us today, you know, the risk of children being murdered, of car accidents and things like that, yes, we’re really anxious about those. But the bigger risks are often going to be longer term risks and they are not so easy to see. It all sounds rather tedious because people have gone on about it so much, but just our lifestyles, obesity, the way people eat, the lack of exercise, and of course the harm to the environment, the energy security, of what might happen, all these things are much more difficult to put a number on for a start. They are also delayed. We’re talking about things a long time in the future. If we are thinking about climate change of course were talking about things for future generations that we need to be concerned about.

And so you’ve got this difficult balance between what you might call acute risks, things that are going to get us today, and what you might call chronic risks that actually we don’t notice at all at the moment, you know, I can just go around stuffing my face with all sorts of food imported and flown from around the world…I mean, I don’t notice any difference, but I will by the end of my life, there’s a very good chance of that, and my children might notice even more. So this is difficult to do mentally. I know people have trouble with it, I have trouble with it.

Robyn Williams: When the volcano in Iceland (whose name you will immediately tell me) went up, what did you tell the people who were phoning you about the risk to do with flying?

David Spiegelhalter: I try not to say anything at all, and I then got invited onto the government advisory committee on volcanic ash, which was an extraordinary experience, it was very interesting because I’ve just started to get more involved in this disaster committee, which has now carried on to trying to work out the chances of a similar event happening in the future. In the UK now they started a thing called a risk register on which the threats to this country which will require some sort of civil planning are supposed to be recorded, and their rough idea of how bad they are going to be and how likely they are to happen is recorded. That’s quite tricky, you’ve got to work out the chance of another eruption by one of these other Icelandic volcanoes over the next five years and how severe it might be. And we got some data on that.

It’s very interesting analysing data that goes back to about 900 on the intervals between volcanic eruptions, and of course they’re very erratic. We know that predicting volcanic eruptions is unbelievably difficult. So it always has to be a mixture of some statistical analysis where you can say, well, we know roughly what the interval is, that we can state roughly what the probability of it erupting again over the next five years is, but there is inevitably going to be a lot of judgement coming into it as well, and that’s why it has to be teamwork between meteorologists and vulcanologists and statisticians. I think that has proved to me that the business of making these judgements about what the risks are is never just a matter of statistical analysis and mathematics, and you have to bring in scientific judgement, and that means acknowledging scientific uncertainty, the fact that we don’t know what’s going on.

We don’t know what’s going to happen. People are quite happy with being able to…they recognise we can’t say exactly what’s going to happen, but to admit that we don’t even know what’s going on at the moment is quite tricky, and yet that is really what scientists have got to do. They are slightly fearful about it. They look at the climate change debate and they see that, oh my goodness, if we admit we’re not quite sure, we’re going to get pounced on and people will say these scientists don’t know what they’re talking about. I have this naive confidence that if scientists really do actually own up, which they do of course amongst themselves all the time, and if they do that more in public and say, well, we’re not quite sure about everything, it doesn’t mean you shouldn’t act because people act all the time in the face of when they’re not absolutely certain of everything, we’ve always had to do that in our lives. But maybe there are some things we’re not sure about, some things we are sure about.

And I’ve been fortunate enough to be involved with a team in the Royal Society that has written a document on the climate change science which really emphasises the uncertainties and which says, well, we’re pretty sure about this stuff but we’re not so sure about this stuff, and this stuff frankly we haven’t got too much idea about at all. And I feel very happy to be involved in that kind of project where we have an open acknowledgement of where we are. It’s difficult, ignorance is a difficult thing to admit. I think embrace your ignorance, own up, say we don’t know. But then we’ve got to try to find out more.

Robyn Williams: Having looked at the risk of regarding climate change and the uncertainties, how would you assess the reasonableness, the wisdom of doing nothing?

David Spiegelhalter: I’m not a climate scientist so I had to take all my evidence second-hand from what other people have told me, what I’ve read, and discussions I’ve had, and the people I’ve talked to are very clear about the inability to make any precise statements about what’s going to happen. However, the weight of evidence is towards that I’d be very surprised if some pretty severe changes were not going to occur over the next 100 years. And so my feeling is that this is a gamble that I’d rather not take, to be honest, and that we should be doing all we can to try to ameliorate it in any way we can. And just because we’re not totally sure, doesn’t mean we shouldn’t do anything. We act all the time when we’re not totally sure of what’s going to happen.

Robyn Williams: Going to gambling and magic, how do you think people are fooled so easily in that kind of showbiz world?

David Spiegelhalter: I love the cons, we’ve got this guy Derren Brown who does all sorts of illusions, he picks lottery balls, he does all sorts of stuff, and it’s so convincing. He does a lovely trick that we use in classrooms all the time where he stands up and says I’m going to flip a coin ten times in a row and it’s going to come up heads every time. He stands there and he flips a coin and it comes up heads every time and you think, wow, isn’t that cool. Later on in the program he shows how he did it. Of course what he did was stand there for nine hours flipping this coin thousands of times until he finally did ten in a row, and they only show that bit of film.

So this is a really good lesson for the kids, the fact that someone tells you a story and you say, whoa, this is really cool…think ‘what am I not seeing?’ It’s really difficult to think ‘what am I not being told?’ So an example I use is you see a hole-in-one on YouTube, of course you know that they hit this damn golf ball thousands of times before they got a hole-in-one, but they only show that bit of film, and we know that in that situation. But of course we might read on a website about how eating this will cure cancer, or some magical cure; ‘I did this and then I got better’. Well, hang on, what about all the stories of people who did this and they didn’t get better? I want to know all the failures, and we don’t get that information. So this is just one of the many psychological biases we have, it’s just one, it’s a really good one, that we only hear what we hear and it’s really difficult to think about what am I not hearing.

Robyn Williams: David Spiegelhalter is the Professor of the Public Understanding of Risk at Cambridge and, as you heard, was one of those working on the Royal Society’s recent publication on climate.

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More.

Listen to Some of my Trend Following Podcasts on Taking Risks in Life and Business: Dan Andrews, David Burkas, and James Altucher.


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Ancient Man Had No Risk Management

Putting risk into the discussion:

“There are just four kinds of bets. There are good bets, bad bets, bets that you win, and bets that you lose. Winning a bad bet can be the most dangerous outcome of all, because a success of that kind can encourage you to take more bad bets in the future. You can also lose a good bet, but if you keep placing good bets, over time, the law of averages will be working for you.”
–Larry Hite, Trader

Continuing:

“Life is nothing more than a series of bets and bets are really nothing more than questions and their answers. There is no real difference between, ‘should I take another hit on this Blackjack hand?’ and ‘Should I get out of the way of that speeding and wildly careening bus?’ Each shares two universal truths: a set of probabilities of potential outcomes and the singular outcome that takes place. Everyday we place hundreds if not thousands of bets – large and small, some seemingly well considered and others made without a second thought. The vast majority of the latter, life’s little gambles made without any thought, might certainly be trivial. ‘Should I tie my shoes?’ Seems to offer no big risk, nor any big reward. While others, such as the aforementioned ‘speeding and wildly careening bus’ would seem to have greater impact on our lives. However, if deciding not to tie your shoes that morning causes you to trip and fall down in the middle of the road when you finally decide to fold your hand and give that careening bus plenty of leeway, well then, in hindsight the trivial has suddenly become paramount.”
–Larry Hite, Trader

Continuing:

“Ancient man had no risk management. Everything was left to ‘fate’ and the whims of the gods. Because ancient man felt that he was merely a victim of circumstance he did not see a need to plan for the future. Therefore, he had no future. In his book Against The Gods: The Remarkable Story Of Risk, Peter Bernstein plots out the history of man’s discovery of the law of probabilities and risk management. Suffice it to say, economic progress seems to run parallel with man’s ability to discover, quantify, and manage risk. Risk and reward are two sides of the same coin. One is not present without the other. You cannot receive the reward unless you are willing to take the risk and you cannot expect to keep that reward unless you learn to mange that risk. It is imperative to master both subjects if you expect to be successful in any endeavor, especially the arena of investing/trading.”
–Source: Pearce Financial LLC

The only thing you can control as you face the markets each day? Your losses.


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Trend Following is for beginners, students and pros in all countries. This is not day trading 5-minute bars, prediction or analyzing fundamentals–it’s Trend Following.

Larry Hite on Risk

Some wise views from Larry Hite:

“We don’t really trade silver…we don’t trade the S&P…we trade the differences. We really are risk managers. We take on risks, try to exploit them and we leave when they turn against us. That is what we get paid for. Basically we are in the risk transfer business. We take on what people want to sell, sell what people want to buy and hope to make a profit. The reason why one goes to a portfolio is because there are real limits to perfect knowledge. I’ll give you an example. Say you knew which commodity, stock or currency would appreciate the most in the following year, and you knew exactly what its price would be. We did this experiment looking backwards in fact in our database. The question of when you take a position is how are you going to trade the line…how much of a position are you going to leverage. Now, if you have perfect knowledge, would you leverage 5 to 1, would you leverage 10 to 1, 2 to 1? Well it turns out that if you leverage more than 3 to 1 that you are a loser. Because we found that if you did 3 to 1 you would have, even with perfect knowledge, you could go down a third. So that, the only perfect knowledge you could have, would be if you knew every wiggle on the line. Then you would know exactly how much to leverage. But you don’t.”

More.


How can you move forward immediately to Trend Following profits? My books and my Flagship Course and Systems are trusted options by clients in 70+ countries.

Also jump in:

Trend Following Podcast Guests
Frequently Asked Questions
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Research
Markets to Trade
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Trend Following is for beginners, students and pros in all countries. This is not day trading 5-minute bars, prediction or analyzing fundamentals–it’s Trend Following.

CalPERS: The Wrong Focus

The California Public Employees’ Retirement System (CalPERS) clearly had a rough go of it in the last 6 months. They lost a great deal of money. Now they seem intent on solving their “problems”. As this document (PDF) shows they are putting in place new rules for how they deal with and select hedge fund investments.

What are some of the big new rules? Well, CalPERS is worried about how much a hedge fund makes. Normal people might be worried first and foremost as to whether a fund returns ‘after fee’ positive performance or perhaps be concerned with the trading strategy employed, but CalPERS is worried about appearances. Clearly, CalPERS is only worried about politics. Does anyone think the great money earners in this world ask the questions CalPERS asks first? Of course not.

I would love to a list of the hedge funds and strategies CalPERS lost money in over the last 6 months. That would tell us a ton about the brain power in charge of all of those pension account monies.

PS. The “confidential” part is great. This is the freaking government!

“Pimping Risk”

This article and excerpt caught my eye

“The [mutual fund] industry sets targets that are far too high and then says, ‘Gee let us help you hit that target — put your money in stocks,'” he says. “It is true that the probability of making your target will go up, but the probability of having a really bad outcome — like losing your principal — will also go up, and so will the fees charged for management.”

Its never about just putting your money in any asset “long only”. Once you decide on the asset class you need a plan for buying and selling before you ever lay one dollar on the table at risk.

Larry Hite: Life Is A Betting Game

From Larry Hite:

“There are just four kinds of bets. There are good bets, bad bets, bets that you win, and bets that you lose. Winning a bad bet can be the most dangerous outcome of all, because a success of that kind can encourage you to take more bad bets in the future, when the odds will be running against you. You can also lose a good bet, no matter how sound the underlying proposition, but if you keep placing good bets, over time, the law of averages will be working for you.”

More on Larry can be found here.

Michael Covel and Larry Hite
Michael Covel and Larry Hite

How can you move forward immediately to Trend Following profits? My books and my Flagship Course and Systems are trusted options by clients in 70+ countries.

Also jump in:

Trend Following Podcast Guests
Frequently Asked Questions
Performance
Research
Markets to Trade
Crisis Times
Trading Technology
About Us

Trend Following is for beginners, students and pros in all countries. This is not day trading 5-minute bars, prediction or analyzing fundamentals–it’s Trend Following.

Michael J. Mauboussin: Perspectives on Risk

Michael J. Mauboussin excerpts (PDF) from a presentation the Greenwich Roundtable:

LTCM used statistical arbitrage to “vacuum up nickels”, as one of the founders, Myron Scholes, described it. One essential component of their portfolio was that it was highly diversified: the correlations between the positions were historically quite low—10 percent or less. To be conservative, in their value at risk models LTCM assumed correlations could jump to 30 percent, vastly higher than anything they saw in their historical data. However, the summer of 1998 saw a real contagion—a diversity breakdown of epic proportions. Notwithstanding the substantial arbitrage opportunities, there were no arbitrageurs to be found, and correlations rocketed higher, to about 70 percent. Add high correlations, leverage, and declining asset prices, and you have the story.

Listen to Michael on the Trend Following podcast.