Thursday, May 13, 2010

The virtue of inconsistency

We often read that we should be consistent traders. Have a plan and then take every signal it generates. Those signals and no others.

The advice may appear sound on the face of it, but Raymond Smullyan challenges it in his inimitable fashion in 5000 B.C. and Other Philosophical Fantasies (St. Martins Press, 1983). He starts with formal mathematical systems where “consistency is absolutely essential, for without it the whole system breaks down and everything can be proved.” But is it true, by extension, that “if a person is inconsistent, he will end up believing everything?” Of course not. Here’s an excerpt from Smullyan’s counter-argument.

“If we were consistent in our inconsistency, then we might end up believing everything, but it is more likely that an inconsistent person would be just as inconsistent in the way he carried out his inconsistency as he is about other things, and this would be the very thing that would save him from believing everything.

“The inconsistent people I have known have not seemed to have a higher ratio of false beliefs to true ones than those who make a superhuman effort to maintain consistency at all costs. True, people who are compulsively consistent will probably save themselves certain false beliefs, but I’m afraid they will also miss many true ones!” (pp. 39-40)

I couldn’t have said it better! But then I’ve never believed that consistency is always a desirable end—and not because, as we often hear, consistency is the hobgoblin of little minds. The accurate Emerson quotation, by the way, is: “A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.”

A trader’s job—and this holds for algo traders and discretionary traders alike—is to figure out when consistency is wise and when it is foolish, when inconsistency can offer greater rewards than consistency.

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