Blind to Chance
The most important factor in the average horse race is not speed, pace, trainers, breeding, nor jockeys. It is chance.
This opinion seems to be a little controversial out there in the handicapping world, so let me clarify a little. Chance is overwhelmingly important in the short term and almost nonexistent in the long term. While a single race is usually mostly determined by random factors, the long-term role of luck is nil.
How can that be? A book (recommended to me by Ron Tiller of Handicapper�s Data Warehouse) I�ve recently read helps explain. Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life, written by Nassim Nicholas Taleb, a senior trader in Wall Street with a Ph.D., M.B.A. and several other initials after his name, is about luck and how we are fooled by our human nature from recognizing randomness in daily life. Its general lessons apply well to trading in futures, both of the Wall Street and the racetrack variety.
The overwhelming importance of chance in the outcome of a single race vs. its insignificance in the long run is explained by the scaling property of randomness. Taleb explains it this way in terms of the market: "A 15% return with a 10% volatility (or uncertainty) per annum translates into a 93% probability of making money in any given year. But seen at a narrow time scale, this translates into a mere 50.02% probability of making money over any given second... This scaling property of randomness is generally misunderstood, even by professionals. I have seen Ph.D.�s argue over a performance observed in a narrow time scale (meaningless by any standard)... Over one year we observe roughly 0.7 parts noise for every one part performance. Over one month, we observe roughly 2.32 parts noise for every one part performance. Over one hour, 30 parts noise for every part performance, and over one second, 1796 parts noise for every one part performance... Over a short time increment, one observes the variability of the portfolio, not the returns... what one observes is at best a combination of variance and returns, not just returns."
"So, even though a trader may have a 93% chance of profitability in a given year, his performance in a given hour is 30-to-1 determined by chance."
So, even though a trader may have a 93% chance of profitability in a given year, his performance in a given hour is 30-to-1 determined by chance. Seen in this light, my previous statement that the outcome of the average race is determined 75% (or 3-to-1) by luck seems conservative. And Taleb is talking about the stock market � I�m talking about horse races, where the volatility of returns is certainly much higher.
But, because of the scaling property of randomness, when a handicapper�s performance is measured over months and years, unless he�s just lucked into a six-figure pick-six, the role of chance virtually disappears. Luck tends to even out in the long run.
Why are we generally unable to fully perceive the role of chance in everyday occurrences? Part of our makeup as humans is a deficiency in the ability to perceive the operation of randomness. Our nature is to make sense of the world around us � we even see patterns in clouds. Taleb says, "We are not wired in a way to understand probability... Researchers of the brain believe that mathematical truths make little sense to our mind, particularly when it comes to the examination of random outcomes."
Handicapping determinists believe if we ran the same race over and over again, the same thing would happen every time. Handicapping probabilists understand that there are, in Taleb�s terms, "alternative sample paths" for any event. While there is some degree of logic to each race and some horses will tend to win more often than others, the degree of randomness inherent in the situation would cause an infinite number of different races (alternative sample paths) to occur.
"Just as one day some primitive tribesman scratched his nose, saw rain falling, and developed an elaborate method of scratching his nose to bring on the much-needed rain," we look at the Racing Form after the sixth race and find explanations for why the winner won. And believe me, they�re always there. NC
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