“The Critically Counterintuitive Code: Cracking the Market’s Hidden Rules”

A few years ago, I came across the concept of the "critical counterintuitive." It's one of the most compelling mental models I have ever encountered and one that you can readily apply to the world of investing.

The "critical counterintuitive" is "critical" because little else really matters. It is "counterintuitive" because the world works in ways almost precisely opposite to the way you think it does.

The "nice guys" who take the flowers and candy route rarely get the girl. The smartest kid in the class seldom becomes rich and famous. The class clowns who make it big are often the ones who have dogs that always eat their homework.

Understanding how you can apply these mental models can spell the difference between your investment success — or bankruptcy

1. Don’t Confuse Luck with Smarts

The role of luck in investment success is deceptively subtle. You may think investing $10,000 into $1 million in a stock is the best thing to ever happen to you.

But you'd be wrong.

After such phenomenal success, you'd think you cracked the code of the markets. The next time, you bet your house, car, and life savings on another "can't lose" investment.

Maybe you'd win this time as well.

You calculate that if you do it only one more time, you'd have $100 million in the bank.

Eventually, however, your luck runs out. Your last investment flops. And since you bet the farm, you lost your shirt and are deeply in debt.

You are worse off than when you started.

You spend the rest of your life trying to replicate your first trade. You tell yourself that you've learned your lesson. And if you do it only one more time, you'll take all your chips off of the table.

That's the problem with sudden wealth.

Whether a big bet on a stock tip or buying a winning lottery ticket, you just got lucky.

What’s worse, most lottery winners end up poorer five years after they've won than beforehand.

As a wise man once said: "If you win a million dollars, you'd best become a millionaire. Because then you get to keep the money."

The lesson? Betting and winning big on an investment does not make you a genius. You were at least as lucky as you were brilliant. Being a one-hit-wonder does not turn you into the Rolling Stones. Over the long term, there are no shortcuts. Making money on a consistent basis is a grind. It's one part "insight" and ten parts "discipline."

2. Your Opinion is Irrelevant to Your Investment Success.

The philosopher Friedrich Nietzsche once observed that "any explanation is better than none."

I disagree. Sometimes, no explanation is necessary—or relevant in the investment world.

Today, we suffer from the paradox of information overload. You have more information about the financial markets in your pocket than the world's top hedge funds did 20 years ago. Yet, I bet your investment returns have not improved one iota.

Not only do we seem incapable of divining the future, but we can't even agree on what happened.

What caused the Great Recession of 2008?

Greenspan's loose monetary policy?

Out of control mortgage brokers? Or President Clinton's push for low-income borrowers?

We crave explanations because they give us an illusion of control.

But it gets even worse.

Cassandras, who got their analysis "right" in predicting the credit crunch, failed to make money for their clients.

Gold didn't hit $5,000 an ounce, the U.S. dollar didn't implode, and Treasurys didn't collapse. Analysts who promised to "crashproof" their clients' portfolios would have fared better with simple index funds.

The lesson? Successful investors are effective in the long term because they admit their mistakes.

As the world's greatest speculator, George Soros said,

"My system doesn't work by making valid predictions. It works by allowing me to recognize when I am wrong."

3. Your “Intelligence” is your Biggest Handicap

Warren Buffett famously observed that it takes just average intelligence to become a successful investor.

I'd add something to that. I'd say high intelligence is a handicap to successful investing.

Here's why...

When you are smart, you are used to being 100% correct. You cannot accept the possibility of being wrong. So you stick to your guns, even when the market is telling you are wrong.

That's why Wall Street analysts make such lousy money managers. And it is why hedge-fund managers who flaunt their intelligence inevitably flounder.

Think about it this way ...

If high intelligence were the key, top business school professors and economists would be the wealthiest guys on the planet.

Instead, the Forbes 400 is populated by dropouts from places like Harvard (Bill Gates and Mark Zuckerberg), Stanford — Elon Musk, and the Google guys. None could have gotten a job on Wall Street, let alone taught at a top business school.

That's also why poker players make the best traders and investors. They play each hand as it is dealt to them. If they get a bad hand, they fold. They play the investment game the same way.

A former dean of Harvard College, Henry Rosovsky, observed about Harvard students: "Our ‘A’ students become professors. Our ‘B’ students go to law school. Our ‘C’ students rule the world."

After all, those "C" students stayed up all night playing poker with Bill Gates.

Critically Counterintuitive Lessons

So, how can you use these "critically counterintuitive" rules to improve your investment returns?

First, never bet too big on one idea. You may get lucky once. Maybe even twice. But your luck eventually will run out. And if you bet the farm, you are out of the investment game for good.

Second, reject the delusion that you have special insight into the market. Lose this intellectual humility, and your head will be handed to you. And it's not a question of "if" but "when."

Third, learn to think of your investments like a hand in a poker game. Up the ante when you are lucky enough to get a good hand. But also be prepared to fold - and to fold often.

As trader Ed Seykota observed: "Some people are born smart. Some people are born lucky. Some people are smart enough to be born lucky."

Here's hoping that you were born lucky!