What separates the great analysts from the good analysts? It is simple, second order thinking. Levels of thinking may lead to reversals in price from what is expected or market responses that are counter intuitive. A shock to a market may not behave as expected because money is flowing based on more complex thinking.
First order thinking is the result of immediate thinking based on what has been expected from the past. It is associated with generalized thinking, based on the concept that all else is equal. It is our initial fast thinking. It would be system 1 Kahneman thinking based on simple intuition. For example, higher gasoline prices will lead to less driving. This immediate conclusion is the end of thinking and does not involve the implications of initial actions. It is reactionary and safe thinking and will be the answer that the majority will use.
Second order thinking will extrapolate and think through the implications of what higher gasoline prices will have on other markets. It will question current assumptions and beliefs. This is system 2 thinking and is a deliberate approach to walk through the logical consequences of some action. It is hard focuses on uncertainty and complexity and my definition will not be conventional.
Second order thinking will walk through what other industries will be affected by the rise in gas prices. It will have an effect on refiners. It will impact travel and entertainment. It will impact demand for electric cars.
Third order effects will look at the implication of the second order effects to move to a third order. If there is higher demand for electric vehicles, there will be an impact on some industrial metals. Some of these higher order effects may prove to be illusionary; however, better analysts will think through events to form multiple hypotheses for opportunities.
Can a quant fund have second order thinking? This is very interesting question because a disciplined approach is often by definition literal. If "A" occurs, then do "B". The relationship between "A" and "B" has a sensitivity or coefficient of X, but the framework is very structured. Yet, second order thinking is critical for a good quant fund. A shock to one market may change the correlation among many assets. Second order thinking of a shock will look for correlation dislocations.
Think beyond the immediate or obvious and realize that others may also be thinking beyond the immediate. It is a game of anticipating the higher order thinking of others.
No comments:
Post a Comment