Crypto investing requires probabilistic thinking - Cryptocurrency Exchange

Any type of investment carries risks and certain uncertainties. When investing in a particular asset, you can’t insist that the outcome will definitely be 100%. Because all kinds of situations can occur, and different situations will lead to different results, you should have a preliminary judgment about the possible probability distributions. It doesn’t have to be perfectly accurate, but you should have a probabilistic forecast rather than wishful thinking that a certain outcome will definitely happen. Therefore, in investment behavior, probabilistic thinking is essential.

For example, when investing in the crypto market or stock market, which is essentially choosing a company, start by selecting companies you are very familiar with. You shouldn’t buy unfamiliar companies because the probability of making mistakes when buying an unfamiliar company is higher. So, choosing companies should be within your capability circle—what is called the “ability circle.” Going beyond this circle makes you vulnerable to others’ manipulation. Like Tang Sanzang, he must stay within the circle drawn by Sun Wukong; if he jumps outside, the chance of making mistakes increases greatly, even risking his life. Inside the circle, he is much safer. So, it’s important to recognize whether your actions are within your capability circle or outside, and whether the probability of success is high or low.

The same applies to companies you invest in. If the industry itself has poor sustainability, then the company’s sustainability is also likely to be poor. For example, in some electronics industries, products are updated rapidly, and the company must constantly make various decisions. The probability of decision errors becomes high, leading to many operational risks. Conversely, some products are very stable, like milk, where consumers don’t need to constantly change flavors or brands. But if a company changes its product every one or two years, the probability of errors increases, and investing in such companies carries a higher risk of failure. Ultimately, the success or failure of an investment depends on whether the company’s future operations succeed.

In probabilistic thinking, we can distinguish between the probability of risk and the probability of return. Generally, the probability of risk is easier to assess, while the probability of return is sometimes more difficult to evaluate. Because the return depends on market transactions, but the lower bound of return can be known—based on the relationship between price and value, the “minimum worth” or safety margin can be estimated. There is a certain probabilistic aspect to the lower limit of returns. Beyond that, the upper limit is generally unknown.

Probabilistic thinking is mainly used for risk assessment. In investment, risk control is paramount, and the probability of risk needs to be systematically evaluated. For example, in the investment process—from selecting a coin or stock to buying, holding, and finally selling—each step involves a probability. A mistake at any stage can lead to failure. Buying well is not enough; holding well is also crucial. The probability of successful investment is the product of the probabilities of each subsystem, so the overall probability is always lower than the individual step probabilities. To improve the overall success rate, it’s best to minimize the number of steps and ensure each step has a high success probability. The product of these high success probabilities results in a higher overall success rate.

Regarding probability, it can be viewed as a form of uncertainty. Enterprises have their own uncertainties, markets have theirs, and investors have theirs. Therefore, efforts should be made to increase the probability of success in each aspect. How to improve enterprise certainty? First, it should be in an industry cycle that is upward and not highly cyclical, with sustainability. For example, as mentioned earlier, products should not be updated too quickly; a product that is popular for a few years and then disappears is not sustainable.

Additionally, products should be simple, with straightforward processes, which reduces the chance of errors. Doing the same thing repeatedly makes the main business clearer, rather than constantly changing products or brands, which involves many competitors and frequent updates. Rapid changes and complex processes naturally increase the likelihood of mistakes. Such companies should be avoided.

Or, if a company is part of a very complex supply chain, heavily controlled by upstream and downstream entities, it is generally not a good company. Its complexity increases the chance of errors, and many aspects are beyond control, making profits more uncertain. For example, the airline industry is like this: prices are uncontrollable, competition is fierce, costs are affected by oil prices, and many airlines’ pilots and crew are unionized, which adds complexity. Airport costs are also uncontrollable, and many uncertainties lead to stagnant profits over the years.

If a company lacks significant competitive advantages, its fate is in the hands of competitors. When they lower prices, the company becomes passive with no pricing power. The entry barrier is too low, leading to high uncertainty. It’s better to avoid overly complex products because any problem in a complex product can cause the entire product to fail.

For example, after the Japanese earthquake, the entire electronics supply chain faced issues; products couldn’t be sold. For instance, a mobile phone with thousands of components cannot be produced if just one component is missing. This illustrates that the more complex the system, the more fragile it is. Fragility means that a small issue can trigger a chain reaction, greatly increasing the probability of systemic errors. This is about how to choose enterprises and industries from an objective perspective.

From a probabilistic standpoint, simpler things are better: simpler supply chains, more stable products, and organizational structures with fewer subsidiaries. Many poor companies like to make their annual reports overly complex, making it hard to understand, which allows them to manipulate or hide performance. Such unknowns are very risky.

A standard for judging interactions with people is that if someone speaks ambiguously, vaguely, or contradicts themselves, one possibility is poor communication skills, but it’s also very likely that they are not trustworthy. If they are good people, they speak clearly, with transparent eyes, and logical thinking. They don’t contradict themselves or hesitate, and they speak straightforwardly. Simplicity correlates with higher success probability.

Also, avoid human weaknesses as much as possible. In the crypto and stock markets, most people lose money mainly due to human nature. We should avoid common psychological pitfalls, such as subjectivity, emotional influence, herd mentality, obsession with short-term actions, volatility, prediction obsession, and constant monitoring. If we can correct or avoid these common psychological errors and habits, our chances of success will increase.

Since most people’s behaviors are wrong, simply not following the crowd can increase your success probability. Contrarian investing works this way: because most people lose money, doing the opposite increases your chances of success. During a downturn, risks are gradually released, and buying in reverse becomes more likely to succeed rather than fail. Without even considering your ability circle, contrarian actions inherently have an advantage in increasing probability.

Short-term prices are generally not real; the shorter the period, the more false or illusory the price. Operating based on short-term fluctuations increases the chance of errors. Conversely, extending the operation cycle reduces mistakes and increases success probability. Therefore, avoid short-term trading, human weaknesses, constant monitoring, the desire for overnight riches, and prediction-driven strategies. Technical analysis, for example, is often unprofitable—99% of the time, it doesn’t make money. If you follow the failures of 99% of traders and operate in the same way, you will inevitably fail. Avoiding these behaviors naturally increases your chances of success.

Furthermore, to improve success probability, avoid areas with many wolves. Places with many wolves are more likely to be prey. For example, some so-called “whale-controlled” coins, small concept coins, or junk coins, often do not make money but are full of hype and news, with messy financial reports. Stay away from such wolf-dense areas to reduce mistakes and losses, thereby increasing your chances of success.

Also, avoid macroeconomic analysis, as the process from macroeconomics to corporate profits involves countless steps, each with its own probability. Success requires all steps to be correct, which makes the overall probability very small. Because of the many steps and the need for the entire path to be correct, relying on macroeconomic analysis is a small-probability event. It’s better not to spend too much time on macroeconomic forecasts.

In summary, avoid human weaknesses—don’t do obviously wrong things like macroeconomic speculation, choosing complex companies or industries, operating outside your ability circle, going to wolf-dense areas, focusing on short-term, blindly following media experts, or chasing quick riches. All these should be avoided.

The above is probabilistic thinking. What are the benefits of probabilistic thinking? Why should we adopt it? Because when making judgments with probabilistic thinking, you feel that an action has a high probability of success, can make more money, or involves less risk. At such times, you should increase your position size—the higher the confidence, the more you should invest. This reflects the concept of probability.

Of course, probability should be combined with odds to determine position size. Probability indicates the success rate and how correct your judgment is; odds indicate how much you can earn if successful. Both are necessary. Like horse racing: first, how likely is the horse to win; second, how much can you earn if it wins. Together, they determine the final position size. With this awareness, if your judgment indicates a high probability, you should invest more.

Everyone should cultivate probabilistic thinking because humans are not naturally rational. When optimistic, they tend to invest all their money—this is a common mistake among retail investors. While optimism is good, it’s important to assess the actual probability of success. Investment is a cognitive game; what needs to be improved is your cognitive ability.

From a psychological perspective, you should choose a healthy and correct mindset, avoid traps, reduce mistakes, and increase your chances of success. Having the right methods and correct cognitive patterns increases the probability of success.