When a combination of skill and luck is what determines whether you win or lose, the skillful tend to win over time. For short periods of time the lucky can imitate the skillful (the signal is blustered by the noise), but there are several reasons why this can’t last. As Michael Mauboussin has been calmly pointing out for years, it’s process, not outcome, that matters.
The best poker players, athletes and investors share a trait: they work on the process and let the outcome follow.
“I should have…” “I knew it…” “Told you so…” All these phrases are red flags that point towards someone overly focused on outcome. Of course, if you can get away with it, it is so much easier to focus on the outcome to justify a decision than the process. But process is what differentiates the skillful from the lucky when making decisions under uncertainty.
In the absence of a unique and unerring strategy on picking the right stocks, getting to the final table at poker tournaments or winning a football match, it is, however, not advisable to ignore the outcome altogether. It is a source of feedback. The crucial point to figure out is how to use the feedback and incorporate it into the process.
This is where having a grasp of the basics of statistical analysis comes in handy. There are rules to bear in mind when drawing inference from the outcomes of random processes. I’d recommend reading The Signal and the Noise (if you haven’t already) for a non-technical and enlightening discussion of this.
Getting to a situation where you win more often than you lose is a typical objective. But, being in a situation where the wins are attributable to skill and the losses are down to bad luck, is a better objective. Relying on good luck is not a good way to get ahead.
The message from the table below has been stuck in my head since first seeing it laid out like this by Michael Mauboussin. While it may not always be clear at first which of the four boxes an outcomes falls into, a combination of good data analysis and a critical sense of why a process should or should not work usually points in the right direction.