Why You Should Approach Investing with a Probabilistic Mindset: You'll Never Know the Exact Cause of Investment Outcomes

As an investor, it's crucial to understand that not only should the company's profits be sustainable, but also the investor's investment approach. So, what is a sustainable investment method? It's approaching it with a probabilistic mindset.So why should we adopt a probabilistic approach? Because we can never truly know the exact cause of the outcome of our investment throughout our lives.Perhaps most individual investors won't fully grasp the meaning of this statement, so let me share a personal anecdote from my past.

Back when I was working as an analyst at a securities firm. Since the main clients of analysts are institutional investors like pension funds, asset management companies, and investment advisory firms, the broker of the corporate sales team providing services to them and the analyst work closely together. At that time, there was a younger brother in the corporate sales team who was around my age and had a similar personality, so we were close not only in terms of work but also in other aspects.

One day, I had a lunch appointment with him. I belonged to the corporate analysis team and had a sector that I was in charge of, but since I didn't think I would stay in the sell-side for a long time, I was personally looking around at companies in other sectors. Among them, the stock price of a company I had been observing closely started to plummet sharply from the morning for no apparent reason. However, our company was at the top of the sell-side window, and the volume of sell orders was overwhelmingly larger than other windows. Judging from the volume, it seemed likely that the seller was an institutional investor rather than a retail investor.

While having lunch with him, I casually asked, "There's this stock, A, and our company has been pouring out a huge amount of sell orders today. Is anything going on?" He immediately replied, "Ah, that's an order from a client I'm in charge of. I'm selling it right now." So I asked him why he was selling it so urgently. And his answer was? Portfolio manager replacement.

In essence, a large asset management company that the brother's client was managing replaced the portfolio manager of one of its funds, and the new manager decided to sell off stocks from the existing portfolio that they didn't like. They planned to use the cash raised to invest in stocks they preferred and start fresh. Stock A was a small-cap stock and didn't have a significant weight in the fund. The new manager knew that offloading a stock with low liquidity quickly would have a considerable impact on its price. However, since it wasn't his performance, and the impact wouldn't be that great, the new manager was eager to start fresh as quickly as possible.

On that day, the stock price of A fell by more than 10%. When I checked the stock bulletin board, there were numerous posts trying to guess the reason for the decline, combining press releases, known facts, and speculation. But who in the market truly knew the reason for the decline? Only the manager who placed the order and the broker who executed it, just two people.

You might have heard that investment is like Go (Baduk), and you need to review the game. In other words, it means that you should reflect on the investment results, compare them with your initial investment ideas, and identify your strengths and weaknesses. It's a meaningful activity for your personal growth.However, at the core of this thought lies the assumption that investment outcomes are solely determined by our skills. But that's largely incorrect. In reality, most investment results are influenced by luck.

The bigger issue isn't just that luck plays a significant role but that we can't even tell which outcomes are due to luck and which are due to skill.To figure that out, we'd need to find every market participant who traded that particular stock during the time of our investment and understand their reasons for trading. What does that mean? It's impossible.The exact cause of the investment results that we consider so important, we will never know throughout our lives, until we die.

I bought stock B, and its price went up, leading to profits, and I sold it. Did my positive view of stock B based on reason C turn out to be correct? Not necessarily. It's more likely due to luck. I purchased stock D, but its price fell, and I had to cut my losses. Does that mean my positive view of D based on reason E was wrong? It's more likely that I was simply unlucky. Of course, there might be occasional instances where my skills are accurately reflected in the results, but we can't identify which ones those are.

What I've learned from working in investment is that there are countless cases of buying/selling specific stocks at certain prices and quantities. Ordinary retail investors can't imagine how many bizarre reasons exist for some people to trade massive amounts. In the case of large-cap stocks, the impact of such supply and demand noise on stock prices is relatively small. However, for small-cap stocks, liquidity is scarce, so this noise can significantly affect their prices.

Some individual investors believe that if you want to pursue alpha, you should focus on small-cap stocks, and they invest primarily in them. They judge whether their ideas were right or wrong based on stock price movements. However, this is akin to a frog in a well judging the world based only on the sky it can see. It's limited.

Therefore, regardless of whether you make or lose money in the short term, if you want to survive in the market for a long time and invest for the long haul, you must engrain one mindset. It's to fight as much as possible where the odds are in your favor and avoid fighting as much as possible where the odds are against you.This involves examining the macro environment to understand those probabilities, observing stock prices that accurately reflect the current market sentiment, and avoiding concentrated investments, even if you're highly confident.

Even when fighting in places where the odds are in your favor, you can still lose. This is because you haven't given the probabilities enough chances to manifest. Therefore, if the probability is favorable, you should increase the number of attempts and extend the investment period. Conversely, even when fighting in places where the odds are against you, you can win. However, that's simply due to good luck. The probability of winning is already low, and you continue to fight? The probability of winning gets even lower. Realizing that you were lucky and leaving the battlefield promptly is a probabilistic approach.