Thinking – Fast and Slow

An amazing book by Daniel Kahneman on how we think and how we think we think! What makes the book great is the fact that it uses examples and anecdotes that are truly counter-intuitive for the first time. He has summarized almost all of his research that he did over 20 years and got him the Nobel Prize.

Two systems – Kahneman argues that we have two kinds of brains. Let’s call them System 1 and System 2. System 1 is where all the intuitive thinking and knee-jerk reactions come from. The interesting part is that this area of your brain is working all the time – beyond your realization. So the next time you think that you are acting greedily – it might not be in-grained in your nature. It could be your System 1 playing a huge part in you doing so because of your surroundings. He extends this idea and goes into the exciting world of priming – How minor perturbations to the environment can affect your behavior. His research shows that (as an example) people are more likely to believe in written words when they are in bold font, when they are written in simple words and even when they have a musical rhyme to them. (Woes unite foes against Woes unite enemies). Even thoughts that are easy to recollect are deemed more believable. This is the realm of “cognitive ease”. System 2 is where all the logical stuff goes on. So if you are asked to multiply 17 and 24 your System 1 would be stuck (unless you are one of those Human calculators!).

Amazingly, our System 2 relies a lot on System 1 and this is the cause of many cognitive biases/errors. This does not mean System 1 is all that bad. Remember the fact about – Laugh for sometime every-day.  Kahneman shows that this is true because of System 1. So when people are asked to hold pencils between their teeth in such a way that they smile – the show positivity when shown some pictures/videos. Holding it the other way – rubber between teeth – so that it makes you frown results in negative thoughts with same pictures/videos. However, we ought to train System 2 to be more self-sufficient and reliable – to not trust System 1 (intuition) all the time. If all this seems trivial consider this –

“People are more likely to solve problems/puzzles when they are written in small font – making it difficult to read. Why?”

Because difficulty in reading strains your brain and System 2 takes over. Once in action you would not be very likely to give the intuitively obvious answer straight-away. By virtue our System 2 is lazy! So lesson drawn – Moderate stress during exams is good! Get those System 2 horses running before the big exam!

“I’m in a very good mood today, and my System 2 is weaker than usual. I should be extra careful.”

On the other hand, your system 1 is happy when you are at ease – “Cognitive ease leads to positive emotion”. He shows that people are more likely to invest in stocks that have pronounceable ticker symbols – and such stocks do well in IPO’s. That has been tested statistically and it is indeed amazing! Other thing that System 1 is very good at doing is finding an explanation for anything that is a major event. Stock market movements and NEWS are often related everyday – NNT pointed this out very beautifully in his book Black Swan – How such events are random, consequential and unpredictable. Yet, almost always we seem to give explanations for this – the so called market gurus have made this a BIG business! All those CNN news can actually make you dumber (as Taleb pointed out). 

Kahneman calls this “associative cognition”, however I think this is more a fallacy that (I hope) can be corrected by training! Although it is true that an even will have a cause, System 1 will accept the most possible and intuitive cause – something that is easy to relate to, easy to explain but by no means the correct one. Worse still, deeming this explanation unbelievable is the Job of System 2. However, most of us just don’t use it. As Robert Shiller (I think) points out, unlearning stuff is important too! Something’s just don’t fit in to regular explanation framework and we should learn with it. The problem is – where do we draw the line? Be an oracle or an ignorant guy?

Making a good first impression – Yes! The age old saying is true. Kahneman studies this in the context of the halo effect. Traits which might be both positive and negative are interpreted depending on the notion we have about the person. So making a good impression would not only help you but it would transform your negative traits into good one. An intelligent – illustrious – stubborn guy is better that a stubborn – intelligent - illustrious guy. Order matters! Sadly we might not control that always!

“The sequence in which we observe characteristics of a person is often determined by chance. Sequence matters, however, because the halo effect increases the weight of first impressions, sometimes to the point that subsequent information is mostly wasted.”

Also, next time you ask someone for advice (which one to choose), do not give them your opinion first!

More on System 1 – Kahneman argues that System 1 is your intuitive brain and many times beyond your control. For example - Evaluating people as attractive or not is a basic assessment. You do that automatically whether or not you want to, and it influences you. He talks about Mental Shotgun – how a train of exogenous thoughts may cloud your judgment. As an example -

Evaluate (as quickly as possible) if the following statements are literally true.

Some roads are snakes.

Some jobs are snakes.

Some jobs are jails.

Were you slow with the 1 and 3 statements? Probably because they might be true metaphorically and that made you stop – even though it was out of context and your mind meandered to a different question.

Taking this a step further the concept of Heuristics and their ability to bias our answers was one of the most interesting parts of the book. As he puts it –

“The normal state of your mind is that you have intuitive feelings and opinions about almost everything that comes your way. You like or dislike people long before you know much about them; you trust or distrust strangers without knowing why; you feel that an enterprise is bound to succeed without analysing it. Whether you state them or not, you often have answers to questions that you do not completely understand, relying on evidence that you can neither explain nor defend.”

The heuristics and bias approach simple means that you (your system 1) always needs to have an answer. Sadly, you always rephrase a difficult question with a substitute one – something that you think is an easier one to answer.

“We concluded that people must somehow simplify that impossible task, and we set out to find how they do it. Our answer was that when called upon to judge probability, people actually judge something else and believe they have judged probability. System 1 often makes this move when faced with difficult target questions, if the answer to a related and easier heuristic question comes readily to mind.”

For guys who have read – Polya (How to solve it) this might seem painful! Polya says - “If you can’t solve a problem, then there is an easier problem you can solve: find it”. But despair not! This is not the System 2 heuristic. Rather this is the System 1 heuristic – which is often in your sub-conscious mind and may be wrong more than often.

This is pretty much the first part of his book. He later digs deeper into this interesting study. Hopefully, it will change the way we think – maybe make the System 2 less lazy and System 1 less ambitious! 

This is a very good book to read. Also read Black Swan - one of the book that inspired Kahneman!

Why I don't want what I don't have !

It was not long ago when Barclay's was involved in the LIBOR scandal. Recently, I read about an UBS trader who managed to lose a huge sum in a matter of one day. Being idle makes you intro-spect and wonder what all this means, especially to someone who was very excited about a career in the financial services industry not long ago. Finally I did not get that chance (for now) but I wonder if that was what I really want.

The likes of HSBC were in the news recently, for something as heinous as "money laundering". I was told that the bank's agents actually would come and collect money from you (your hard earned black money), deposit it in your Swiss Bank account and keep you updated! That affected me a lot. I for one was very excited about getting into the industry because of the rush it gives you (keeping you up on copious amount of caffeine), opportunities to meet genuinely smart people and ability to solve problems that are relevant. However, my perception has changed a lot. Maybe this is the "justification syndrome" that most of us suffer from. The idea of "sour grapes" comes to your minds I guess. But then, who gives a fudge? You should neither..

What really attracted me to the financial industry ?

1. Money - There is no denying that money is something that plays a key role in many people's life (all of us shallow mortals) and all the BIG bonus that one hears about is bound to attract them to the industry. Wall street is a dream from many of the graduates from IIT's (the other one being the Silicon valley!) and that is where you want to be, amidst all the happenings!

2. Fame - Probably not unless you are a Soros or Buffet who can make it really huge. The industry definitely does not give you the autonomy you enjoy as a entrepreneur! There is that hollow feeling - I am making money for a firm that might be using it to help drug lords in trafficking them, helping billionaires launder money or helping a rebel nation develop secret nuclear technology (See - Credit Suisse - one of the firms that actually rejected me - for good I guess !).

3. Impact - Again probably not unless you are a trader. But then one needs to define impact in a more narrow way. Is impact about changing something in the world/changing the lives of people or is it about being able to swell your organizations balance sheet (without getting caught)!

I remember this part form the movie Inside Job - A banker telling a regulator - "We will be greedy. You have got to bring in the rules and control us".

This might be the lowest I could go in my life. The question is - Can money fill a void created by such a shallowness?

Not the end of the story -

Do not despair! There are many other jobs where you still have a good overlap of all 3 things but it is difficult to find them since they are rare. I am amazed by way in which money can really blind us, especially someone who is just starting his/her career.

Moreover, that is how the society judges us. Slowly that becomes the way we start judging ourselves.

So does that mean I have given up on breaking into the financial industry? No way! I will probably become a regulator and screw all these guys for their evil-deeds someday!

From black to grey to (I wish) white swans!

I finally managed to finish reading the much hyped book by Mr. Taleb - "Black swans". 

I had not known that getting a Job would be such a big deal if one was graduating from (supposedly) one of India's top school. Nevertheless  the last few months kept me very busy with all the "preparations" for the Job interviews, learning how to be "The guy" that the hiring firm wants! 

On-to the book now - 

Black swans and the G.I.F - 

It was an interesting read for me. It had a lot of grounding in things that I thought were intuitive but ignored by us lesser mortals in our daily lives. On of the few things that I will remember from the book after an year would be that way he denounced the ubiquitous "Gaussian Bell Curve" as a "Great Intellectual Fraud". His reasoning is as follows - 

-- The Gaussian distribution is (sadly) such that it does not allow for extreme events to happen ( more technically - the odds of an extreme event are very low). However,  our lives are shaped by such extreme events - be it hurricanes, stock market crashes or un-foreseen inventions. Why then do we use the "bell curve" to predict the future ? Worse still we justify such shocks and never learn the basic fact that we cannot predict! The world would be a much better place if we could learn to exploit uncertainty, embrace it in it's wildest form. Interestingly, such events have a black (unexpected) connotation to them - Black Thursday, Black Monday. How ignorant can we humans be?

He has come down heavily on the Nobel Laureates such as Merton-Scholes for being a phony - making up theories that have assumptions conjured up by a guy from some dream-land, far fetched from reality. I agree a lot with this point. Many of our theories today are based on un-realistic assumptions (read "Gauss bell curve"), but the question is - Can we do better? Since I know a bit about financial markets (I think!) I'll take an example from that domain - 

Say you invested in Microsoft in 1999. The stock was doing better that good and you see good returns. The black swan is the "Dot-com crash". It is true that not many people saw this improbable event and it had a high (negative) impact on many people. But two questions arise - 

1. Do we learn ? I think we (read some good economists) do. A few good people were able to predict the housing crisis. (Eg. "Has financial development made the world riskier" - R. Rajan). We do realise that such things exist and we can possibly do something about them. Maybe this does not extend this to other domains but the idea is certainly there. 

2. Do we stop going out because on some bad day we might be killed in a road accident or struck by thunderbolts? No !  Black swans are a part of life (as he says). Whether he is concerned about us being ignorant about it or being oblivious to it is unclear.

"Why we don't learn that we don't learn"

This is another interesting chapter that further exemplifies our ignorance towards events. The so-called pundits make predictions, fail miserably and then justify it. They are worse off than a cab driver who has the guts to say "I don't know" when asked about the weather tomorrow. 

Take away point - It is as important (if not more) to know what you don't/cannot know (and not be foolish about it) as it is to know things and make predictions. 

"So what to do about it?"

Almost all the interesting stuff happens in the Extremistan world - where the improbable (one freak occurrence) can invalidate your whole theory, mess up your predictions. We still tend to think that we are in the Mediocristan world - where things "average" out. 

Barbell strategy - "Hedge yourself from such black swans by investing your money/time/energy in low risk places. Assess the Black swan - if it has a possible positive outcome (shorting something and it crashes - George Soros style) invest 10-15 % of your money in it. (I apologize for the proclivity for the financial markets) Otherwise, stay away from it. Financial market analysts know about markets as much as a cab driver but somehow people (foolishly) put a lot of faith in them! He recommends the use of "Fractals", demonstrating beautifully how they can give you hints about black swans and make them grey. 

Last piece of advise - Be a sceptic. This was one of the key take-away's for me. If you have a theory, do not discard the outliers. Search for the one data point that can screw up your theory (We usually do it the other way round - confirmation bias is ingrained in us). Don't fall for the Ludic fallacy (read the book to know what it means!). 

P.S - Next time someone says - "Dude! This follows the normal distribution, have a good laugh at the fool. "