How volatile is your mood? Do you find yourself having unpredictable and sharp movements in how you feel? Bad day at work ruin your mood? I certainly found that one bad thing happening out of the blue with my startup would have caused a sharp drop in my mood right away. It would suddenly drag me down into the depths, like a shark grabbing the leg of a swimmer. My mood would spring back up to normal as I experienced positive experiences but the sheer cliff I had fallen from would still cast a large shadow. How can you manage your emotions better for greater long-term stability? I’m going to make a convincing case for how you can do this, or your money back.
Let’s pump the brakes and deploy the parachute.
Ups and downs are natural, we ought to expect them, welcome them, it is all part of the human experience, it is the dark that gives light meaning. The issue comes from extreme volatility.
If we track our mood on one axis. One dimension, say a single hobby, or a single relationship or a single ambitious pursuit. It moves up and down as that pursuit succeeds or fails, like a stock price of a company. This means that if the CEO suddenly decides to leave or a factory burns down we would expect the stock price to suddenly fall. This is logical. Unexpected bad thing happens, market reacts adversely (and strongly). Similarly we react badly when we argue with a partner, we lose a karate competition, or a pitch is not well-received by an investor.
We’ve probably all heard that you need to diversify things to minimise risk, but most people don’t really understand why. It’s like pulling the ripcord on your parachute.
A lot of the time there are things we cannot predict. One of my favourite aphorisms about investing is that “you can make the right decision and have a bad outcome, you can make a bad decision and have a good outcome”. Obviously, we fear the former a whole lot more. This is just to say, you can get “lucky” and you can get “unlucky”. Things that are unforeseen are common and by definition cannot be predicted. But, they can be allowed for… through diversification.
If we assume things we cannot predict will occur, we can create systems to water down their effects.
Stochastic Variance (or… breaking apart the jargon)
There is a mathematical principle where the average of a set of values moves “more slowly” or with less variance, than any individual value in the set. Imagine these values are a time-series – meaning a new one is added after a repeating time interval, perhaps every day. As each one is added the average will move. It will move by less than the distance between the previous average and the new point.
So if the new point is 10 units away from the ‘old average’ then the new average will be less than 10 points away from the ‘old average’.
The rolling average of a time-series of points is called the ‘moving average’. There are Simple Moving Averages (SMA) and Exponential Moving Averages (EMA). I just described SMAs above, simply averaging the values like normal.
EMAs weight the values that are more recent more highly. I.e. the value yesterday is more impactful than the value 20 or 30 days ago.
This is the main difference, SMAs value everything equally, EMAs value them with a recency bias. The formula for EMAs is far more complicated and not necessary to dig into here, but feel free to read about them on Investopedia here.
What’s the point?
Let’s tie this complex analogy back to reality. I am proposing our emotional memories work more like EMAs than SMAs.
We process both difficult and positive experiences over time, at first they are incredibly fresh and raw. Eventually, they become normalised and their impact is diluted.
So the more recent a positive or negative experience is the more impactful it will be on your emotional well-being (your stock price). We give recent events far more power over us as they reflect the current state of affairs of your life, which naturally brings risks than a distant past. Seeing a lion 5 years ago should be less scary than seeing a lion 5 minutes ago.
This demonstrates what happens when you only consider volatility across one dimension (one stock, or one life pursuit). It swings violently.
Swinging a dead cat (bounce)
Now the real kicker, extending the ‘stocks analogy’ from before. The technique used by investors to counter unpredictability is diversification. The reason for this is that the ‘moving average’ principle generalises to higher dimensions. A fancy way of saying, “yeah you can look over time at one life-pursuit (or stock) and see its moving average performance but you can also have 10 of these moving averages and combine them into a meta moving average too.”
This new portfolio moving average will move even slower than any individual stock or pursuit that it contains. This is inherent to the definition of an average that I describe above.
It is a formalisation of the thought process, “well I lost my competition, but at least I go home to a supportive family which I have a good relationship with. And yesterday I started a painting I’m very proud of”.
Leveling Up your portfolio
Now you can also get fancy. There is no need to treat them as a Simple Moving Average, you can apply weightings. Perhaps it is more important to you to fulfil the role of a good spouse than it is to become a black-belt in Karate. But having each of these dimensions to your personality will mean you will consider the EMA rather than any single one alone. Resulting in a greater stability in the emergent self-esteem that comes from living honestly to your values.
Not to mention how much easier making really tough decisions becomes.
Simply put, having more than one thing you value about yourself will make you less susceptible to feeling like shit about yourself.
In the end, this is purely a more complete argument for the diversification of how you value yourself. It was this realisation that sparked this whole Diversify Your Self-Esteem initiative to begin with.
See the original article here. These articles work in tandem. This one on Moving Averages, that one on Value Hierarchies.
There are two distinct steps here, before you can add these additional dimensions you must first decide what they are. Which requires mapping your Value Hierarchy.
- Figure out what your skill/value tree looks like, draw it up.
- Decide which you will pick for now. Allocate weightings to them based on their position in your Value Hierarchy. You can always promote or demote them later. Just like you would increase or reduce your position in an individual stock to control your exposure.
The most interesting patterns emerge when we cross discipline boundaries. These systems are all spawned from the goopy mess of our brains so they share patterns and model each other. The stock market is the nervous system of society (driven by consumer behaviour and public feelings/sentiment instead of electrical signals and pain like it is in the body).
Nature demonstrates the pervasiveness of patterns through the craziness of the Fibonacci Sequence which also happens to rear its ugly head in stock price analysis (see Fibonacci Support and Resistance for more). Coincidence?
Let’s be more deliberate with how we spread ourselves out. Just like you would be when allocating your assets to match your risk tolerance.