In his book – Against the Gods: The Remarkable Story of Risk, Peter Bernstein explains why investing is a logicians trap. Here’s an excerpt from the book:
We cannot enter data about the future into the computer because such data are inaccessible to us. So we pour in data from the past to fuel the decision-making mechanisms created by our models, be they linear or nonlinear.
But therein lies the logician’s trap: past data from real life constitute a sequence of events rather than a set of independent observations, which is what the laws of probability demand.
History provides us with only one sample of the economy and the capital markets, not with thousands of separate and randomly distributed numbers. Even though many economic and financial variables fall into distributions that approximate a bell curve, the picture is never perfect.
Once again, resemblance to truth is not the same as truth. It is in those outliers and imperfections that the wildness lurks.
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