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The Key to Investing: Predicting the Future (a little more often than the next guy)

Have you ever thought about what kind of power you would really possess if you were able to predict the future? You would be able to do a lot more than just impress your friends by being able to predict esoteric events such as handing someone a handkerchief before they sneeze or winning your celebrity death pool every year.

Actually take a moment and think about it. What is stock trading? What is Forex? What is poker? For that matter, what he is gambling? Deep down at its basic most fundamental level? Three words. Predicting the future.

Imagine that if you knew in advance that out of the thousands of companies involved in computers in the 1980s, you knew that Microsoft would become the biggest, most successful company of them all. How much money do you think you could have made? If you had just a small sum of say, $1000, how many times over do you think you could have multiplied that?

Imagine, for a moment, that you knew that the new England patriots were destined to lose their last two Super Bowl games. Imagine you knew the final scores. You could do a lot more than with that then just when the betting pool with you and your friends watching the game. Online bookies take all sorts of strange, weird, and outlandish bets on everything from the final score to who wins the initial coin toss. And if you knew to 100% certainty the result you could bet everything you owned on those outcomes.

Okay, but enough fantasizing. You can’t tell the future, I can’t predict the future, and nobody can. Or can we? How accurate do you need to be before you can start to treat outcomes as certainties? If my girlfriend comes up to me one day and says “do these pants make me look fat”, I can make a fairly accurate prediction in that my immediate future is about to take a downturn.

And more pertinently, what if, for example, I offered you at that in which we flip a coin, and you guess whether it comes up heads or tails. Guess correctly, I will give you a dollar. Guess incorrectly, you pay me $.90. How accurate does your future predicting have to be to make money? 50-50 starts to sound pretty good doesn’t it?

And while I’m certainly not going to offer you a dollar versus $.90 to predict a coin flip, believe it or not, those kinds of propositions are not uncommon. In fact, they are everywhere. But they are cunningly disguised. Which is actually a good thing. Because if they were easy to find, then everyone would be abusing them.

In the poker world, that is what we call expected value. More specifically, it is the difference between the risk of losing times the amount you stand to lose, versus the amount that you stand to win should things work out in your favor. If the upside is bigger than the downside, you have positive expected value, and thus, a damn fine bet.

This, generally speaking, is the difference between gambling and investing. Investors have a very good idea of what they’re expected value on a bet, a trade, or an investment is. Gamblers just slap their money on the table based on hunch or a feeling, and hope for the best. It is absolutely vital that we always remember this distinction. Warren Buffett, one of the greatest investors of all time, made his fortune by knowing the difference between his risk and his reward. And the city of Las Vegas was built off of the money of people that don’t.

4 Comments

  1. Akiko says:

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  2. Isabela says:

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  3. Diva says:

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  4. Crispiana says:

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