All investors and traders want to get better as decision-makers. They are open to learning and improvement, and a natural way to gain this improvement is through reviewing their actions after the fact. The adage is that we will learn from our mistakes. If you have a thorough review process, you can form an effective feedback loop to ensure future decisions will not be driven by past mistakes.
For a larger money management firm, if something goes wrong, everyone will be called into a room to try and assess what could have been done better. The investment committee will review the decisions to get it right next time by incorporating what was learned into future decisions. Make the trade, do the review, and learn.
What if we got the ordering of learning wrong? Gary Klein, an influential figure in natural decision-making, suggests an opposite approach. Focus on a premortem. Researchers have found that prospective hindsight is an effective tool for improving decision-making. Imagine a negative event has occurred and then trace back to the event’s root cause. Before the decision is acted upon, review what could go wrong. Walk through all of the scenarios for failure. The process of finding out what will go wrong will stop bad decisions from happening. There is no need to have a postmortem if the bad decision was never made. Review. Learn. Do the trade.
If a trader wants to put on a long bond position, the premortem approach would have the trader assume the position went against him and then walk through with his peers all of the reasons why this strategy went wrong. Did inflation move higher? Did economic growth increase? Did bond volatility increase? By looking at the reasons for failure, the trader may rethink his actions.
Klein has also suggested a promortem. Assume that strategy was put into place and everything went well. Then, the decision-maker can walk through the set of events that made it work. This should be a natural part of the decision process for any trader and is an excellent exercise to provide the narrative for why an investment could go well with some details. A decision walkthrough can reduce the need to review future failures.