What Is Inversion And How Can You Apply To Trading?

Thinking the opposite to uncover new possibilities. Inversion is a practice of negative visualization and addressing problems backward.

Using inversion as a model in finance is not unique and there is at least one person out there applying it to make money on the financial markets for several decades with some success. The person I am talking about is Charlie Munger, vice chairman of Berkshire Hathaway and good companion of Warren Buffet. Although he is not as wealthy as the famous Warren, he also made several Billions of Dollars. No too bad either. Munger is also one of the best-known supporters and advocates of the inversion model.

“All I want to know is where I’m going to die, so I’ll never go there.”

– Charlie Munger

This quote perfectly illustrates the method of inversion. Instead of asking yourself, how to stay healthy and grow old, you can turn the question upside down: “How can I make sure that I am not getting old?”. This sounds a bit macabre at first, but the answers to this question helps us to avoid exactly these and support us in living a healthy and long life. Disaster of some kind cannot be foreseen of course, but the probability can be reduced.

Another example from Charlie Munger:

“In the war, Munger was tasked with drawing weather maps. But what he was actually doing was clearing pilots to take flights.

Charlie asked a simple question: “Suppose I want to kill a lot of pilots. What would be the easy way to do it?”

He figured out there were only two ways to do that:

1) Get the planes into cold temperatures that would cause them to ice up and crash, or

2) Get the pilot into an area where he would run out of fuel before he could safely land.

So, Munger avoided these two scenarios at all costs. He became a better meteorologist, and probably saved lives, by inverting the problem.” (retrieved from https://www.wealest.com/articles/inversion-examples - 20.01.2022)

The concept of inversion goes back to the German mathematician Carl Gustav Jacob Jacobi and his saying "invert, always invert". He used this technique solve complex mathematical problems, by approaching them from the back. Not that I would understand any of these complex problems or could solve them by applying the method of inversion to them, but it is possible to use this mental model to apply them to various aspects in life. One of them is trading! Invert.

Inversion in Trading

Let’s bring it to the field of trading and have a look how inversion can help us here. Trading is mostly about planning, gathering information and decision making. This often involves solving problems and estimating probabilities. The perfect landscape for inversion. As we all want to be profitable it is most important avoid failure or losing trades. Of course, they cannot be avoided completely but limited down.

“Success is overvalued. Avoiding failure matters more.”

– James Clear

This aligns perfectly with Warren Buffet’s rules on investing:

“The first rule of an investment is don't lose [money]. And the second rule of an investment is don't forget the first rule.”

These rules can of course also be applied one-to-one to trading. To become a consistently profitable trader it is important to keep your capital. Your trading capital is your number one operating resource. Think of it like you are running a company. Instead of warehouses, machines, and various other equipment your need to produce a product and turn it into revenue and profit. As a trader beside your computer, it is your capital that is crucial for staying in operation.

So instead of aiming for x amount in profits, traders need to focus on keeping their capital in hand. This is already the first step to apply the mental model of inversion to trading. Of course, this is the simplest one and you probably read it a million times already by other traders, but most likely not in the context of inversion. Nevertheless, following this simple step as your number one rule on trading will bring you closer to becoming profitable. Sometimes the way to your goal, making money, is by avoiding losing some.

Where else could you apply inversion to trading? The short answer on every problem you encounter in trading. Always ask yourself, what is the problem that I am currently facing in trading and what would be the inversion of it.

You may have seen this already, some traders even invert their charts to get another perspective and challenge their view on the markets.

Have a look at the comparison of the BTCUSDT chart inverted and the normal one. Try to look at them as different assets, like you are looking at a chart of Bitcoin and Gold for example. Are your expectations for those assets completely contrary? Or does the look at both charts opens you another perspective on the underlying assets and your expectations for them?

I can only speak for myself here but checking the inverted chart occasionally, opens my mind for different for views on certain assets and they often influence my outlook on future positions in the market. In the given case it might look like a good area for reversal for Bitcoin ;)

Another aspect where I like to apply inversion. When I notice that my trading performance is declining, and I am not able find a solution right away. I first try to reverse the problem in a simplified way and find solutions for that. If I am still not capable to solve it, I approach the question of my under performance in more and more detail.

To give you an example, starting on a high level:  if you are asking yourself: How can I constantly make money out of trading?

Invert it and ask yourself: What is the best way losing money in the markets?

Possible answers (add more if they may apply to you):

• Ignore your trading system

• Gamble

• Not waiting for confirmation of the trade (e.g. candle close)

• Rush into a position aka FOMO (fear-of-missing-out)

• Not using a stop loss

We could continue this list almost indefinitely and find more reasons how to lose money and this is already one of the biggest advantages. It is often much easier to find reasons why something is not working instead of finding the solution to a problem. Also, often the solution to a problem is avoiding things that cause the problem.

From this point you can already start and try to avoid all the things you have listed that cause your problems in trading. Next you could pick one or several of the reasons we just identified and dig deeper on them.

For example: How can I fomo in to a trade? – Definitely something you want to avoid.

• Following trading setups you saw on Twitter

• Jumping into any coins that just recently pumped and not yet corrected significantly

• Long or short in large green or red candles without thinking about it

You could even take it down the line even further. But I think it illustrates the mental approach of inversion and how you can apply it to trading.

Inversion in my opinion is great tool to improve your problem-solving capacity and capabilities in trading and other aspects of life. As always in trading and life it is not holy grail and various mental models can be applied to your daily decision making.  

Final Considerations

Inversion in my opinion is great tool to improve your problem-solving capacity and capabilities in trading and other aspects of life. As always in trading and life it is not holy grail and various mental models can be applied to your daily decision making.  

This article is a bit shorter that usual, but it shows how simple this approach is and how easily it can be applied. Still it can have a great impact on you. KISS - Keep it stupid simple!

You want to learn more about mental models, check Farnam Street. The dedicated many articles on the concept of mental models.

If you are new to trading and even if you are around for while. Remember to keep it simple. Over engineering often does more harm than good.

And now a few final words my own interest, I try to provide all my content for free and I will stick to it. So, if you enjoy reading my post and find the stuff helpful I would appreciate it if you spread the word and follow me on Twitter, Telegram and every where else. Cheers!