We all know that too little exercise, lashings of fast food and copious amounts of alcohol are bad for us. If only it were so simple to lead a healthy life by just knowing where the pitfalls lie. The key of course is only dabbling in small doses and above all being consistent. Throw in a tiring, stressful week at work and the opportunity to consume and the best laid dietary and exercise routine goes out the window.
The same delicate balancing act faces sports bettors and financial investors. In my previous article I detailed the top 10 emotional and cognitive biases. All told psychologists have identified that we suffer from well over 100 biases. Knowing those biases helps us know what to avoid. But in the same way that we know where the dodgy dietary choices lie, to never succumb to temptation is akin to admitting you are a robot.
In my previous article I remarked that if you can keep your head, while everyone else is losing theirs, then you can be there to exploit the mistakes of others and scoop up what is being left on the table. If you haven’t read it yet I’d urge you to check it out. Hint: focus on the folly of the many, not the few.
We know from other areas of life that knowing what negative factors to avoid is not enough. Instead, we need to know what positive factors to strive for. Only then can you bulletproof your betting and profit from the folly of others. According to Nassim Taleb, "Even once we are aware of our biases, we must recognise that knowledge does not equal behaviour. The solution lies in designing and adopting an investment process that is at least partially robust to behavioural decision-making errors."
Less is more
One of the most important biases that affects bettors is availability bias: what we remember is influenced by many things including beliefs, expectations, emotions, and feelings as well as things like the frequency of exposure. As Daniel Kahneman remarked, availability bias is "largely determined by the extent of coverage in the media."
It's much more than this though. The risk of being susceptible to all behavioural biases can be avoided if your mind is clear. Here are 5 ways you can achieve this in how you approach your media and information consumption habits:
- Be intentional about your sports and financial news media process. Allocate a certain time of the day to review the news. Whatever you do, don’t have news headlines popping up in real time or otherwise you will let that news define your process.
- The most important news and analysis is rare. The most important media content includes news and analysis that requires you to take immediate action. This should be extremely rare. Remember, the person producing the content doesn’t know you personally, or your portfolio. The second most important type of content changes how you think about an important topic.
- Be a market historian. It will teach you that most headlines were not that important, and so not worth worrying about. It will teach you that understanding headlines and their propensity to extrapolate trends can sometimes be an important indicator of a trend reversal. Finally, being a student of market history means you have much more experience to fall back on than just your limited lived experience; beware that our early and recent betting experiences tend to loom larger than they ought when we make decisions.
- Try to consume content across different disciplines; history, psychology, finance, sports, …etc. According to emerging market investor Barton Biggs, "The successful macro investor must be some magical mixture of an acute analyst, an investment scholar, a listener, a historian, a river boat gambler, and be a voracious reader. Reading is crucial..."
- Consume media content that you disagree with, by people that you respect. The plethora of media channels available make it very hard to seek out alternative viewpoints. Seeking out well-structured arguments, even if you disagree with them enables you to gain a better understanding of the financial world that we live in.
According to Daniel Crosby, author of The Behavioural Investor, "Keeping your head in an information age designed to help you lose it is the never-ending task of the behavioural investor." But being consistent in your approach to information will mean your mind is uncluttered, allowing you to think clearly. It’s an edge you’ll have over the other 99.9%.
Take the outside view
We typically make decisions by focusing on the specific task and by using information that is close at hand. In turn we make predictions based on that same narrow and unique set of inputs. The ‘inside view’ includes anecdotal evidence and erroneous perceptions. We make the mistake of thinking we are representative of everyone else; the biases ‘availability’ and ‘recency’, outlined previously dominate our thinking.
The 'outside view' is different. It asks if there are similar situations that can provide a statistical basis for making a decision. Rather than seeing a market as unique, the outside view wants to know if there have been similar examples in the past and, if so, what happened. The outside view is an unnatural way to think because it forces bettors to set aside all the cherished information they have gathered. So how can you start to use the outside view to make better betting decisions?
- First, you need to sample. Gather a large sample of similar situations. Larger sample sets are always best and consider looking for examples outside of your narrow interest, for example matches played in lower leagues or in different countries.
- Next, analyse. Study the distribution of outcomes and note the average and extreme successes and failures. Some may follow a normal bell-shaped distribution; others might exhibit a large skew while some may show a power law distribution. Bear in mind thought that the failures may be much harder to see.
- Third, adjust. Construct a forecast based on the historical statistical outcomes - not to meet your own intuitive expectations.
- The final stage is to iterate depending on the degree of randomness or skill involved. If the event you are betting on is highly random then you should regress your forecast outcome substantially towards the mean, but if skill matters to a large degree then much less iteration is required.
As Michael Mauboussin says in his book Think Twice: Harnessing the Power of Counterintuition, "The main tip from the inside-outside view is that while decision makers tend to dwell on uniqueness [and are therefore prone to biases], the best decisions often derive from sameness."
Before you make a bet, think about what the future could look like if the decision was incorrect; how did the decision go wrong, where were the flaws in the argument, and what could you have done differently? Carrying out a pre-mortem means forcing yourself to think about the bet from another perspective.
Also known as 'prospective hindsight' this method can sometimes open-up new ways of thinking, but it also helps to reduce one of the main emotional biases to affect bettors and investors - overconfidence. Using a pre-mortem helps to offset one of the manifestations of overconfidence, over-precision.
One of the challenges with generating long term returns from sports betting or investing is receiving feedback. We might think that we have a sound process, but how can we tell? In the short-term, chance plays a much bigger role in the outcome of events, something that may cause us to question or worse bin our well-honed process.
One way to address the problem of a lack of feedback is to identify signposts and assign numerical probabilities that they occur. Think about a bettor looking to make long-term returns. He or she is trying to generate excess returns by backing certain outcomes occurring with the belief that they have a variant perception not appreciated by the market. As information related to those specific differences is revealed, you can think of yourself as passing a signpost that tells you whether you are on the right path. According to Michael Mauboussin, a useful signpost has three features: it has an outcome that can be objectively agreed upon, within a specified date, and is important to the overall thesis.
One way to reduce the likelihood of behavioural biases affecting your betting is to automate. This could be a simple rules-based approach that includes a checklist (much like a pilot uses before take-off) to ensure that nothing gets glossed over in the heat of decision making. A far better method is to automate completely, bet recommendation and execution.
We have all heard stories of gamblers who seemingly driven on a spark of intuitive genius won a massive bet after backing the 50/1 outsider. These stories happen somewhere in the world every day. If you are in for long-term success research consistently shows that models outperform human intuition in predicting the future, especially when it’s about anticipating future human behaviour. A meta-analysis referenced in the book DIY Financial Advisor found that models beat expert decision making a huge 94.12% of the time.
One way to get over the urge to just go with your instinct is to let a model do the heavy lifting, analysing the data and computing the probabilities, and then allow a small room for tweaking at the end. Daniel Kahneman calls this "disciplined intuition." The evidence shows that allowing a small amount of wiggle room improves the overall quality of a betting decision.
Investors should also take the necessary steps to focus on the time horizon that is relevant to them. If a trade is based on your outlook over the next week then worrying about opinions in the media on the outlook over the next decade are useless; vice versa if you are focused on the long term.
By imitating Ulysses (whose crew bound him to the mast of his ship to protect him from the call of the Sirens), you could take steps to only be exposed to financial news relevant for the time period you are most concerned about.
If that doesn't work, follow the example of Ulysses crew, and put wax in your ears! If you find yourself disagreeing with someone’s opinion over the future direction of a particular financial asset, ask yourself whether they are playing a different time horizon to you.
Learn to do nothing
The human brain has an evolutionary tendency towards action. Sports bettors and traders are no different. Many first approach speculation with the idea that they must always be doing something. Always bringing in a weekly wage to show for their efforts. A bit like a ‘normal’ job.
Research examining the difference between male and female traders found that men typically traded 45% more often than the women. All this extra activity came to nought. Even worse, it led to worse performance. The average male trader underperformed the average female trader by 1.4 percentage points per year.
One of the greatest speculators the world has ever seen, Jesse Livermore left the world with a fountain of knowledge on the rules of speculation. When Jesse was young, he was no different to the rest of the novice bettors. He would frequent the ‘bucket shops’ of the era daily, scalping positions in various financial markets.
As he matured, Jesse developed into a great trader by developing a low maintenance, high patience approach to investing. Two of my favourite Jesse Livermore quotes come from the book Reminiscences of a Stock Operator, published in 1923 and based on his life: "Money is made by sitting, not trading," and "It was never my thinking that made the big money for me, it always was sitting."
Sitting, not betting. Waiting for the right opportunity. It’s one of the ways to guard against the endowment effect and regret aversion, and it’s also a route to capitalising on the folly of others. It’s a behavioural trait recognised by more recent investors too.
Be emotionally aware
Avoid making decisions while at emotional extremes. Stress, anger, fear, anxiety, greed and euphoria are all mental states that tend to affect the quality of our decisions. Our emotions tend to go into overdrive when we think about money, to the detriment of our working memory and our ability to avoid succumbing to bias.
Brian Knutson of Stanford University has shown that investors tend to behave in a rational way most of the time; until they suffer a loss. Monitoring the brain activity in volunteer investors he found that losses lighted up the pain centre of the brain. In turn this prompted an irrational preference for the certainty of safer but poorer performing investments such as bonds.
Our fragile human bodies hold onto fear and anxiety. Without a release valve the pressure builds up only for it to be released in one go at the worst possible time, which tends to coincide with the moment we need to make a big decision. Research suggests that we lose roughly 13% of our cognitive capacity under stress.
Envy is another deadly emotional sin when it comes to betting. It really shouldn’t be, as investor Charlie Munger explains, "The idea of caring that someone is making money faster [than you] is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on that trolley?"
One way to regain focus of your emotions is through one of the various forms of meditation. According to the U.S. Department of Health and Human Services, National Institutes of Health (NIH), "Meditation is a mind and body practice that has a long history of use for increasing calmness and physical relaxation, improving psychological balance, coping with illness, and enhancing overall health and well-being. Mind and body practices focus on the interactions among the brain, mind, body, and behaviour."
Sensitivity to your emotional state has been found to be a strong predictor of success in financial trading. A study led by Cambridge University of 18 hedge fund managers found that those who could sense the state of their body made more money and survived for longer in tumultuous financial markets. Still not convinced? Well, billionaire hedge fund manager Ray Dalio swears by meditation, noting that it is "the single most important reason" for his success.Sensitivity to your emotional state has been found to be a strong predictor of success in financial trading.
And so while being more emotionally aware should make you more psychologically resistant to the inevitable ups and downs of the markets - whether you are a sports bettor or an investor – it should make you more successful too.
Watch your energy levels
Our energy levels also play a big part. Ever had hunger pangs leaving you feeling irritable? I think we can all relate to that sensation. An empty stomach screaming "feed me!" certainly isn’t conducive to well-reasoned decision making. Indeed, we tend to be more risk seeking when hungry, but more risk averse when sated.
Perhaps the most famous example of the way our energy levels affect our decision making comes from the legal profession. An analysis of parole board hearings from Israeli prisons over a 10-month period revealed that your chances were heavily influenced by whether the judge had recently had a meal.
The study found that prisoners who attended the parole board hearing right after the judge enjoyed breakfast had a 65% chance of parole. Pity the prisoner who turned up just before lunch; the study found that on average the harshest sentences were handed out right before the judge departed for lunch. Later the judge returned to the bench. Refreshed and energised the chance of parole rebounded, only to gradually fall away as the afternoon wore on…until snack time when, you guessed it the judges’ clemency miraculously returned. What can you do to keep check of your emotions, enabling you to make better sports betting decisions?
One idea is to create a checklist. Whenever we are at our most emotional, we often overlook important information. Checklists are routinely used by doctors and pilots to make sure that they are following best practice. Unlike these professions which are relatively stable, and where cause and effect is clear, many of the decisions we face are far less clear cut. Keep your checklist general, focusing on the high-level principles.
Keep it simple
Much of what you can do to protect yourself from behavioural biases centres on how you structure your betting and investments. It’s not just a frame of mind, it’s also how you should conduct the business of betting.
First, get the right balance between concentration and diversification. The adage is "Don’t put all your eggs in one basket", yet the only way to generate wealth is to concentrate your investments. Your portfolio can be a lot more concentrated that you think, while also generating strong returns and reducing behavioural bias risk. Investors from John Maynard Keynes to Warren Buffet have advocated owning no more than a dozen investments. Indeed, research suggests that risk adjusted performance increases by knowing a lot about the few rather than nothing about the numerous.
Second, be aware of your real-life goals, i.e. your true utility function. It probably isn’t making profit for profit’s sake, but for what that money will enable you to do. Make sure your betting / investment related goals are consistent with your real-world goals. Bet staking strategies tend to be framed around the Kelly Criterion. Following Kelly blindly - without giving enough consideration to your personal utility – increases the risk that you see wild swings in your performance. Overall, this increases the chances of succumbing to behavioural biases.
Third, use the instruments that are consistent with your risk/reward preferences. This means structuring it so that you can express the position, but also so that you can sleep at night. Decide a priori your maximum risk, bearing in mind that leverage means you could lose far more than you meant to. This might mean fixed odds betting is more suitable than spread betting for example. If a bet goes sour and it has the potential to blow up your portfolio it will drain you of emotional energy just dwelling on it. Far better to keep the position size manageable to ensure that you can think about it rationally, and crucially also have the bandwidth to consider other opportunities.
Finally, stop watching your performance in real-time. If you have a long-term time horizon (for example 1-3 years), then reviewing the value of your investments or the size of your betting bankroll every day will drive you nuts. Remember that next time one of your friends boasts about their seven screens, live sports feeds and rolling news coverage. In the book Fooled by Randomness, author Nassim Taleb describes the impact that watching live market updates has on the life of an otherwise happily retired dentist:
"A 15% return with a 10% volatility (or uncertainty) per annum translates into a 93% probability of success in any given year. But seen at a narrow time scale, this translates into a mere 50.02% probability of success over any given second… Over the very narrow time increment, the observation will reveal close to nothing. Yet the dentist's heart will not tell him that. Being emotional, he feels a pang with every loss, as it shows in red on his screen. He feels some pleasure when the performance is positive, but not in equivalent amount as the pain when the performance is negative"
We know what biases to avoid, but how can we stop being, well…human? The answer lies not in focusing on the negatives, but instead making those positive changes that improve our performance. A bulletproof diet should include reducing empty media calories, taking the outside view, automating to focus on the long-term, learning to do nothing, being aware of emotions and energy and lastly, keeping it simple.
Adopting the bulletproof diet of the behavioural bettor means seeing the world from a different perspective. One where we stand aloft of our tendencies to do absolutely the wrong thing, at the wrong time. Rather than rail against those biases, the bulletproof diet means we can observe the folly of others and position our bets accordingly.