Deepak Dhayanithy in his book “Strategy Huddle” talks about a very interesting event to understand behavioral strategy .
This is about Andre Agassi telling the world how he had an important “tell” when he faced his great rival, Boris Becker. The “tell” was that Boris tended to stick his tongue out, pointing towards the direction of where he was going to serve. So, if Becker was serving at deuce and he was going to serve wide of the court, his tongue would point towards left and so on. Agassi picked up on this “tell” and won a significant majority of his matches against Becker. Also, Agassi only used this “tell” selectively in big matches only.
Game theory Optimal Vs Exploitative
Well, today the poker world is increasingly debating between GTO vs Exploitative play. What Agassi was doing was exploitative play and he used it optimally to ensure Boris Becker did not adjust his game accordingly and not allowing him the Game theory optimal play. While, Boris Becker picked up poker after Tennis and was a celebrity Pro at PokerStars, given he had to declare bankruptcy, he was not likely good at it. And given Agassi’s observational skills, I am pretty sure he could have been a great poker player.
The book “Strategy huddle” is a goldmine of many such incidents from the world of sports. For a football fan, the book is a must read, given the number of examples of game changing strategies in the world of football listed in the books. The book covers 27 different sports phenomena across 9 chapters and with each chapter themed on a strategic management topic.
The reason to get into any bet or trade is to take an advantage of the pay-outs because of the edge that you have. The edge could be a function of knowledge or skill. In sports, poker or trading, the side that wins in the long run is the one with Edge . In this blog, we try to showcase how two unseemingly opposite behavioural biases that are irrational a big source of profit for the gambling industry and brokerages.
Can one have edge in Coin toss?
If I asked you to bet Rs 100 on a coin toss. And every time you win, I paid you Rs 97 (Rs 3 being commission) – Will you bet? The answer to this simple question is a clear No, as you have no edge. Even the most compulsive gamblers know that this is a losing proposition and will stay away from this bet. However, if I tell you that heads occurred 8 out of 10 times in recent attempt. Would you now bet? Are thoughts of the coin being not fare racing your mind?
One of the most crowded tables in any casino is the roulette table. The roulette table is nothing but a coin toss with 37 outcomes (0-36) and you get paid only 36 times, in effect 1/37 being the casinos commission. A proposition which is equally worse to the coin toss with 97% pay-out. The reason people are betting on the roulette table is that because many people think that they can identify sequences. To nudge the gamblers, roulette tables display the last 20 numbers and Hot and Cold numbers (those being hit frequently and not) – a behavioural trick to trigger the delusions.
In a game of roulette, the ball has just landed on red seven times in a row. This leads you to believe that it will probably land on red again, so you increase your stake and bet on red. The false idea is that past events are somehow influencing current events. Even though, in the case of a roulette table, each spin is completely independent of the previous. Of course, the odds of getting red are exactly the same as black, just like in all of the previous spins.
Gamblers Fallacies are at play: Monte Carlo fallacy & Hot hand fallacy
The hot-hand fallacy occurs when gamblers think that a winning streak is more likely to continue. The belief is based on the idea that having already won a number of bets improves the probability that they will win the next bet or the next number of bets, too. Luck will continue favouring them as they are running hot.
Monte Carlo fallacy or its inverse the “Hot-hand” fallacy is a huge source of big profits for the gambling and betting industry. While, basic common sense says that a toss of a coin is a independent event and has nothing to do with previous events as the coin does not know it came heads before. However, when a string of results of independent events are presented the irrational mind is quick in identifying sequences in it and forecasting the future with a higher degree of certainty.
Monte Carlo fallacy nickname was borne out of a particularly crazy night at a Monte Carlo Casino on August 18,1913 when the roulette ball fell into the black 26 times in a row. The probability of this happening is a staggering 1 in 136.8 million. Not even the most seasoned gamblers had ever seen a roulette wheel favour one outcome so heavily. This Monte Carlo casino raked in millions of Francs that night, thanks to the gambler’s fallacy. In fact, it was one of the most profitable nights of all time for any casino, as bettors kept betting on a reversal of outcome.
Hot-hand fallacy is derived from basketball where observers expected a high scorer to keep on scoring. A claim that players are more likely to make a successful shot if the previous shot was successful.
Match fixing – Unintended consequences on betting
For every cricket match, betting sites like betfair.com and bet365 gives odds of a team winning the toss. Pay-out is generally 95% on this site for getting the toss right. As discussed earlier, there is no reason for anybody to bet on a toss without an even pay-out, as there is no edge. However, there are enough gamblers who bet on the same and the toss section is a very active market on the betting sites. But Why? Other than the gamblers and hot hand fallacy there is one another key reason. Its fixed.
Two instances of toss fixing have been widely circulated :
These 2 instances though debatable are enough to fuel imaginations of gamblers and forecasting advice of insiders who claim to accurately give out tips on who will win the toss. Billions of dollars are wagered on sites on who will win the toss in cricket. Purely because they have been advised by a bookie or an insider. Or simply put the belief that the coin is not fair.
Fun Fact: Faf Du Plesis (Former South African cricket captain) has the record of losing 10 consecutive toss. Now if after the 7th toss loss by Faf du Plesis would you be willing to bet on the 8th toss of a win or a loss. Well the answer lies whether you believe in Hot hands streak or not. Faf du Plesis himself though was convinced of his bad luck and for the 10th toss brought his deputy Temba Buvama as proxy captain to the toss but still lost.
Do day traders really have an edge?
The stock markets see a lot of intraday volumes. With delivery volumes being only a fraction of traded volumes. These are basically people trading on an intraday basis on the basis of chart patterns. There is prospering industry of technical analysts giving intra day calls and Buy today, sell tomorrow ( BTST) calls. There are multiple subscription services of such calls available and regularly given freely on business channels. Where does the edge come from?
Technical analysts are either believers in the hot hand fallacy. Trends and patterns are analyzed and stocks going up or down are expected to continue doing so.
Everything is fixed (Like Match fixing). Regular stock rigging scams convince traders that its possible to make money by getting tips from insiders and being early into a stock manipulation trade.
The edge be it in sports betting or intra-day trading comes from insiders/fixers who seem to know more. But do they really? Well one can never say. However, the possibility of the edge has fuelled the sports betting and intra-day trading industry.
Being stuck in Poker or Investing means that you are currently losing money. In poker, this could refer to your current session or this could refer to your cumulative results over a little while. Being stuck in investing or trading means that you continue to hold an investment/stock because you are losing money in it.
The Key reason for this behaviour is Hope for a turnaround. (As per investors, it is a proven hypothesis that stocks always move up after they SELL)
Most poker players who are STUCK will continue to play a session with the hope of recovering the losses. This is when you see poker player instead of playing 4-8 hours session playing for 12-36 hours at a stretch because they are stuck. One does not come across players who continues to play more than 20 hours if he is significantly up. Same is true in investing most people tend to hold on stock which are down 30-70% for eternity with the hope the companies will turnaround someday. The same investors rarely hold on to stocks which have given them 4-5x times returns.
Pain from loss leads to Risk seeking both in poker and investing to cover up the losses. Poker players showcase by playing trashy hands and investors showcase it by Averaging down or investing in penny stocks.
Risk taking increases when faced with imminent losses:
For example, what would you choose…?
Scenario 1: To receive a guaranteed payment of $900 or take a 90% chance of winning $1000 (and a 10% chance of winning 0)?
Scenario 2: To choose between losing $900 and take a 90% chance of losing $1000?
In Scenario 1, most people would decide to avoid the risk and take the $900 though the expected outcome is the same in both cases. In Scenario 2, people tend to choose the 90% chance. While, the reason for selecting between taking the chance or not should be a function of inherent risk taking nature of a person. However, in case of scenario 2 even the most conservative people tend to take the chance.
The Sunk cost trap
Sunk cost trap refers to a tendency for people to irrationally follow through on an activity that is not meeting their expectations. This is because of the time and/or money that is already invested. This is why people finish movies they are not enjoying and finish meals that taste bad.
Most people stuck in loss making stocks always tell me that they will sell off as soon as the stock recovers to its cost price. The same is in poker, people continue to play a session until they have recovered their losses.
Investors conisder selling a stock in loss as a personal failure instead of conidering it as a natural outcome of probablistic event. you hold on to the stocks and argue that the market is not getting it and someday it will to satisfy your ego. The same is true in poker, professionals think its benith them to have a loss making session as they are better than the quorum. So they keep extending a session – most likely end up with severly battered egos in both case.
How to get UNSTUCK
In investing, the mantra is to evaluate all your stocks periodically on purely fundamental basis. Well this is easier said than done. If you are not ready to BUY more of a stock at current level – maybe it time to Sell it. However, the problem with our loss-making positions is confirmation bias sets in and we are mostly searching for information that justifies the investment. Any information which is against our thesis is discounted and we continue to remain invested in a stock which has halved, convincing yourself for fundamental reasons.
Some behavioural tricks to overcome STUCK
Compulsory exit worst stock
Exit a session after X BUY-in.
Not look at Profit/loss or acquisition price before making a decision to SELL
Decide to continue playing based on edge over quorum rather than Profit/loss.
Take external advice for every stock that has corrected 30-50%
Ask a friend, if you are tilting or playing Right.
Pre-decide holding period at time of Buying say 3/5/10 years
Pre-decide playing time before start of session say 3/5/7 hours.
Or remember Legendary Paul Tudor Jones Wallpaper: LOSERS AVERAGE LOSERS
Years ago investor Mohnish Pabrai lost big on an investment in a troubled lender called Delta Financial. Soon after he did an interview with SmartMoney magazine:
SmartMoney: How do you deal with Delta Financial, profession- ally and personally? Pabrai: Investing is a game of probability. Sometimes when you make favorable bets, you still lose them. Even a blue chip could go to zero tomorrow. With Delta Financial, the company didn’t have enough financial strength — that was probably a mistake on my part. I think of it as a favorable starting blackjack hand where unfavorable cards showed up afterward.
SmartMoney: If you could do it over, would you have done the same thing?
Poker is all about
making bets when you know the odds are in your favor. A player with Aces in
Texas Holdem is 4:1 favorite and in PLO (Omaha) Aces edge pre-flop might just
be a 3:2 favorite. This basically means even when you play when odds are in
favor you are not guaranteed to win. A poker player playing a hand when the
odds are in his favor is a good player and not the person who wins the
hand. However, it can occur that a good
player can lose for a long time because of luck factor.
Ed Thorpe, an investor and former successful blackjack card-counter, writes in his book that the best card-counting method provides a mere 2% edge over the house. Which means you’ll spend a lot of time losing. His road to blackjack success was paved with agony: I lost steadily, and after four hours I was behind $1,700 and discouraged. Of course, I knew that just as the house can lose in the short run even though it has the advantage in a game, so a card counter can fall behind and this can last for hours or, sometimes, even days. Persisting, I waited for the deck to become favorable just one more time.
Michael Mauboussin –
Do not Confuse Outcome and Process
Being result oriented comes easily as we tend to evaluate our decision based on the outcome. This happens frequently in poker and Investing. Mohnish Pabrai didn’t in the case of Delta financial because he believed his decision making process was fine.
Many fund Managers with significant exposure to a sector or because they have a sector fund in vogue may end up out performing despite a failed investment process. This was true for some managers in 2006-08 with significant exposure to Real estate companies like Lanco infratech, DLF, HDIL, Jai Corp. While, in case of investing the bad process can be hidden for years and at times can go unnoticed, in poker one can know for every hand whether the process was right based on Odds and not the outcome. If a poker player, adopts consistently bad process he will end up losing in the long run. In case of investing though, the evaluation and judgment of process is not so easy to make.
Losing faith after inevitable losses despite a sound, probabilistic predictions can cause people to quit predicting even when they’re technically good at it. This is true for both poker players and investors. The focus should always be on the Process and luck can be evened out in the long run.
PS: This blog was
triggered after a Professional poker player losing a big hand immediately said
– I played right. He had made the right