I am a professional forecaster. That is, I must attempt to predict the future with a relative degree of accuracy, although in a narrow regard, for particular microeconomic data sets. How does this make me different from a fortune teller? I conduct data exploration and analysis, apply statistical, time series, judgmental, and theoretical techniques, relying on domain specific expertise to guide initial assumptions, decompose data into trend and season, isolating cycles and irregular components, locate independent indicator variables, design predictive models, back test, extrapolate, recommend a forecast of the future in terms of probabilities of outcomes, including opportunities, risks, and uncertainties, monitor, audit, analyze variances, revisit assumptions, recalibrate models, and do it again. A fortune teller conducts an intuitive reading of a client, or querant, using the preferred medium for symbol interpretation, such as tarot cards, astrology, palm reading, runes, tea leaves, I Ching, or a crystal ball, believing that messages from mysterious sources, whether spiritual or subconscious, lend insight into earthly concerns, but can only provide vague metaphorical elucidation of the signs, relying on the querant to fill in the specific details. I am clearly not a fortune teller, but there is one way in which we are very similar. For both of us, the most critical aspect of our services is the utility that the prediction provides for our customer, in terms of the decisions it influences, the actions it engenders, the course it corrects, or the path it puts them on.
To demonstrate the ontological importance of prediction upon action, and the power of reflexivity, consider a thought experiment, a tale of two billionaire investors. The first billionaire employs expensive computer engineers and statisticians, who leverage the latest technology, in both the processing power of the hardware and algorithmic sophistication of the software, for forecasting the direction of markets, estimating the risks and opportunities inherent in each transaction, coupling the correct trades to the correct moments in time, anticipating large moves through early trend detection, and automating strategies, so as to avoid endemic human predictive fallibility, brought on by cognitive biases. Each of the many investments, and investment strategies, in the first billionaire’s portfolio are mapped against a substantial collection of pertinent causal variables, macroeconomic metrics, early trade detection sniffers, dynamic real-time autonomous data collection and analysis on equity, bond, currency, commodity, and options markets, and even the latest in social media trend tracking. This high speed business intelligence is set to statistically sound risk thresholds, and comes with the cutting edge in “black swan” detection software. Low probability, high impact events, like a sudden catastrophic stock market crash, will be noticed in their opening stages, and positions can be liquidated by the software without delay, saving millions of dollars that would otherwise be lost waiting for a human to calculate the decision. The forecasting system, called LapDem 1.0, after the determinist mathematician Pierre-Simon Laplace, works so well that the first billionaire has convinced his investment clients to rely on its predictions as well, roughly doubling his own fortune, putting a significant share of capital within the control of extremely smart, semi-autonomous, software.
The second billionaire is a self made man, has shunned specialized forecasting software, and relies on his own intelligence, experience, and intuition to anticipate the future, and to make his investment decisions. He has always trusted his gut, felt the room, been willing to take risks, and bet against the odds. A portfolio as high yielding as his requires an uncanny ability to time the market, the savvy to buy and sell the right assets and securities at the right moments. His early entry into extremely profitable ventures is only rivaled by his opportune exit from expiring enterprises, a bold builder of capital and pious preserver of wealth. However, the second billionaire is not arrogant, he knows the limits of his intellect and intuition, and during times of dramatic uncertainty, he will consult a trusted fortune teller, a tarot card reading mystic. Although not overly superstitious, the second billionaire believes that his fortune teller has given useful advice, and has never led him astray, even if it amounted to the subjective interpretation of her cryptic ramblings, which simply matched the meanings of the arcane symbols on her tarot cards to generalized metaphors and vague pronouncements. But even if she never clearly stated the direction of the market in a measurable sense, the second billionaire had always found that the predictions of his mystic gave him the insight he needed, in order to make the decisions he needed to make, which in hindsight always turned out for the best.
On a particularly fateful Friday, early in the morning, the second billionaire wakes up from a horrible dream, one in which he loses his entire fortune in an unforeseen and unpredictable event; a dreaded black swan. The nightmare puts him in a panic, a panic so deep he jumps outs of bed, logs into his computer to check his investments, even after he checks the time and realizes that markets won’t open for another hour, and erratically scans his holdings. Everything is as it was last night. A quick glance at the international news and market reports, and there is nothing out of the ordinary, nothing that would cause him alarm on a normal Friday morning. Yet this nagging sensation of impending doom will not go away. He decides to consult his fortune teller, and gets his driver to race him to her home immediately, which is where she does her readings. The mystic is furious when he wakes her, out of a pleasant dream, with persistent knocks at her front door.
The second billionaire is able to calm the fortune teller down enough to agree to do an emergency reading, after a sizable offer of cash. She leads him inside to a small room, decorated in tapestries with symbols and mystical motifs, with a table, chairs for them to sit, a deck of tarot cards resting on a dark purple tablecloth, waiting to be shuffled by him. Once he has sorted the deck to his liking, he hands it back to the fortune teller, watches and listens as she drew several of the cards and lays them on the table in a complex pattern, explaining the meaning of each card, in consideration of the context created by their place in the pattern. Even with a sizable fee extracted from her wealthy client, the fortune teller’s annoyance at being woken suddenly gets the better of her, so she tells the second billionaire under no uncertain terms that the cards say he will experience a catastrophic and unexpected event that will change his life forever. She cannot tell him what to do exactly, but if he is to forestall the consequences of this event, he must leave her now and take immediate action. He races out the door. The fortune teller goes back to bed.
The second billionaire calls his office from the car, and gives the order to his assistant to sell everything. After some cautionary, unrequested, and unheeded advice, the second billionaire’s assistant gets off the phone, and begins making calls. Within minutes the process of liquidating the second billionaire’s positions is underway, ringing the smart alarm bells on LapDemon 1.0’s market risk sensors, the first billionaire’s state-of-the-art forecasting intelligence kicks in and instantly concludes that there is extremely abnormal market activity afoot, and determines that a black swan event is imminent. LapDemon 1.0 initiates a full liquidation order, for both the first billionaire’s and his client’s portfolios, and the automated selling routines are triggered, with the sell-orders hitting the market in seconds, and the situation is well underway before the first billionaire is even aware that he is liquid cash. The massive volume of trades, between the first and second billionaire’s selling activity, does not go unnoticed by other market participants, and these initial market moves spook the other players, little and big alike. There is a race for the exits, and before the day is through, the stock market has lost 10% of its capitalization, a sum much greater than the combined fortune’s of the two billionaires. The media, in an attempt to explain the crash, latches on to whatever coincidental event it can, citing military clashes in the Middle East, political factors in Asia, extreme weather in the Midwest, and many other speculative but reasonable conclusions. The true cause of the black swan, an event that leads to a deep economic slump, is never understood by the public, although everyone generally agrees that it was an amalgamation of reasons.
In hindsight, both billionaire’s are not able to see that they each had a significant role in the crash happening to begin with, and never become aware of the true nature of this event either. They both believe that their respective forecasting systems were instrumental in preventing a loss of their personal fortunes. The first billionaire thinks that LapDemon 1.0 was the best investment he has ever made, and his clients do to. It sold ahead of the crash quicker than any human analyst could have, justifying the use of this automated forecasting and trading software. The second billionaire believes that his tarot card reader had been amazingly prescient, and thinks he was right to trust his instincts that morning. He does not realize that his selling orders triggered the crash itself. Even the fortune teller, after having deliberately misread her cards in order to give the second billionaire a snarky reading, reinterprets the situation, marvels at her predictive acuity, and believes that her powers of foresight can be enhanced by strong emotional intensity, and modifies her reading atmosphere, so as to increase her passions during while she interprets the cards.
Which billionaire had a better forecasting method in this situation? They both turned out to be correct, and both avoided losing their fortunes, at least as far as they each can tell. However, consider that if the first billionaire had not utilized the LapDemon 1.0 forecasting system, his slower human analysts would have picked up to the fact that the second billionaire’s trades were an anomaly, not related to real world events, would have bought on the dip, with good price opportunities, and in the long run his fortune would have been increased more; a classic tortoise and hare story. However, the first billionaire does not know about this counterfactual outcome. If the second billionaire had not panicked about the dire, but very vague premonitions from an irritated fortune teller, he would not have sold his holdings, would have seen them increase healthily instead, been holey better off, but like the first billionaire will always remain blissfully unaware of this more fortuitous future; the proverbial self-fulfilling prophecy.
In my two billionaire’s scenario, both forecasting systems and the forecasts they produced were flawed, in the sense that the forecasts themselves caused reflexive actions that resulted in a worse outcome for all parties involved, while at the same time masking these flaws from the users of the forecasting systems. If you think my thought experiment is contrived, or unrealistic, consider the flash crash on May 6th, 2010, a sudden intraday stock market drop of 900 points, and a sharp rebound within minutes. It was the largest daily move in Dow Jones Industrial Average (DJIA) history, and spawned many theories from a large fat-fingered trade, to computerized trading algorithms run amuck. The situation I describe is possible, but even if it were not, I only mean for it to demonstrate some points about forecasting.
The power of forecasts is in the actions that the forecasts themselves instigate. Action items are the primary utilitarian function of any prediction of the future. A prediction that generates an action causes a real effect in the world, a real tangible effect precipitated by an imagined, immaterial, teleological suggestion about potentialities. Action carried out for a purpose establishes the utility of a forecast, and in this regard the professional forecaster and the fortune teller may both produce predictions that have value, at least considered from the view of the client, the forecast consumer. Even more interesting, to me anyway, is that a forecaster has the power to shape reality with a forecast, a forecast that is itself an intangible thought experiment. As a professional forecaster I must consider the advice giving aspect of my job seriously, along with other indicators of good forecasting, such as accuracy and credibility, and I don’t think I could be as successful in this role if my method were reading tarot cards. Does a tarot card reading fortune teller ever wonder what action items are generated by their predictions?
Jared Roy Endicott