What Investors And Traders Can Learn From Atul Gawande’s The Checklist Manifesto

The Checklist Manifesto by Atul Gawande.

This weekend I reread The Checklist Manifesto, a book published in 2010, which argues the case for a systematic approach to our daily work as professionals. Below you find arguments for why I believe a checklist should be a part of the toolkit of any aspiring speculator or investor.

Both Charlie Munger and Warren Buffett use checklists. Buffett has a mental one, while I believe Munger has a written one. They both liked The Checklist Manifesto and Gawande was subsequently hired as CEO for the healthcare project between Amazon, Berkshire and JP Morgan.

Lesson number one: Avoiding mistakes

..whether running to the store to buy ingredients for a cake, preparing an airplane for takeoff, or evaluating a sick  person in the hospital, if you miss just one key thing, you might as well not have made the effort at all.

The aviation industry is famous for their extensive use of checklists. The pilots perform checklists for starting the engines, takeoff, landing etc: whatever needs to be done involves a checklist. There is a simple reason for this: checklists are simply extremely effective in avoiding mistakes when facing complex and/or repetitive tasks. Humankind often fails on these tasks because we tend to forget or skip important steps, which result in grave mistakes and accidents.  The more tasks and the more complex, the more valuable are checklists.

Evolution has designed our brains to take shortcuts and hasty decisions. On the savanna, when you see a predator, you simply run without thinking, a typical System 1 decision. But investing and trading should be about System 2 decisions, and checklists are a tremendous tool in achieving that.

I believe one of the most important skillset in investing is to avoid unforced errors. Victor Niederhoffer wrote the following in The Education of A Speculator:

There are so many ways to lose, but so few ways to win. Perhaps the best way to achieve victory is to master all the rules for disaster and then concentrate on avoiding them.

As part of a checklist you might do as my Swedish friend, Håkan: When he has backtested a potential good strategy, he tests it live (without real money) for at least six months. If it works well for six months, he starts trading with small amounts of real money. If not, it ends up in the bin (or being retested later). Very few strategies make it past this test and thus saving him a lot of money.

In medicine, one must avoid both false positives and false negatives. But in investing you need to avoid false positives, and a checklist comes handy.

Lesson number 2: Increase your skills

If you have a useful checklist, you actually improve your outcome without any increase in skills.

Lesson number 3: You save time

The benefits of making fewer mistakes are obvious. Furthermore, a checklist gives you an efficiency edge, as you can dismiss a trade or investment pretty fast. It gives you an edge because most investors dislike checklists because they are (usually) tedious, boring and for many even an embarrassment. When looking for a presumable great and undervalued business, you start reading, run the numbers and later arrive at a conclusion. This is unlikely to be as effective as a checklist where you can easily and quickly sort companies as either “In”, “Out” or “Too difficult” (as Charlie Munger puts it). You don’t need a lot of good strategies or investments to be successful.

I made a written checklist for both my short-term trading and long-term investing a long time ago. I believe you should as well.

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