I have recently read “Thinking in Bets” by Annie Duke and the memo “You Bet” by Howard Marks. Annie is a professional poker player while Howard Marks is the chairman of Oaktree Capital Management. Below some interesting ideas from their writings.
“Over time, those world-class poker players taught me to understand what a bet really is: a decision about an uncertain future. . . “
Life is poker, not chess. Chess contains no hidden information and very little luck. Poker, in contrast, is a game of incomplete information. It’s a game of decision-making under conditions of uncertainty over time. Valuable information remains hidden and there is also an element of luck in any outcome. The real world is closer to poker than chess. Uncertainty and luck take part in the game. The outcome is a combination of both luck and the quality of our decisions under uncertainty.
Thinking in bets starts with recognizing that there are exactly two things that determine how our lives turn out: the quality of our decisions and luck. Learning to recognize the difference between the two is what thinking in bets is all about. Winning and losing are only loose signals of decision quality. You can win lucky hands and lose unlucky ones.
What Makes A Good Decision
In the books, there is a story that many football fans have said is the worst play call in Super Bowl history.
For those that may not remember, the Seattle Seahawks were down by 4 points with 26 seconds left in the game with the ball on the one-yard line. The head coach of the Seattle Seahawks, Pete Carroll, called a pass play instead of handing off the ball to one of the best running backs in the NFL. The pass was intercepted and the New England Patriots won the Super Bowl.
When the details of the situation are clearly discussed in the book — the number of downs and time outs left, along with the fact that not one of the sixty-six passes attempted from the one-yard line that season were intercepted (only 2% of such passes in the last 15 years!) — the decision to the throw seems to make much more sense.
We can make the best possible decisions and still not get the result we want. Improving decision quality is about increasing our chances of good outcomes, not guaranteeing them. What makes a decision great is not that it has a great outcome. A great decision is the result of a good process.
What good poker players and good decision-makers have in common is their comfort with the world being an uncertain and unpredictable place. They understand that they can almost never know exactly how something will turn out. They embrace that uncertainty and, instead of focusing on being sure, they try to figure out how unsure they are, making their best guess at the chances that different outcomes will occur.
Focus On Things You Can Control
Sure, you can manipulate your opponents to do certain actions, but you can’t put a gun to his head and make him fold. You certainly cannot control the cards you’re dealt and the runout of cards. That said, all you can do is control how you react to the things that happen to you during a game. You can control your emotions, and the moves that you make. Applying this to real life, you should think about how you react when people treat you poorly or when life throws you curve balls. All you can do is focus on the decisions you make personally and be happy with that.
A World Of Randomness
An expert in any field will have an advantage over a rookie. But neither the veteran nor the rookie can be sure what the next flip will look like. The veteran will just have a better guess. The world is a pretty random place. The influence of luck makes it impossible to predict exactly how things will turn out, and all the hidden information makes it even worse.
“Great decisions don’t always lead to great outcomes, bad decisions don’t always lead to bad outcomes.”
A great poker player who has a good-sized advantage over the other players at the table, making significantly better strategic decisions, will still be losing over 40% of the time at the end of eight hours of play. That’s a whole lot of wrong. And it’s not just confined to poker.
The difference between a great player and a world champion is the absolute confidence it takes to “pull the trigger” on a decision without a millisecond’s thought or hesitation.
In the short run, luck and variance predominate. In the long run, skill and determination win.
The “Resulting” Effect
Going back to the story above, if the play worked, Carroll would have been praised for his great decision. Consequently, if it didn’t, he would have been widely criticized. As many of us know now, he became a victim of our tendency to equate the quality of a decision with its outcome.
Poker players call this “resulting.” Veteran poker players recognize this effect and resist the temptation to change their strategy if they have a few bad hands.
Why is this important to an investor? Because “resulting” and other human cognitive errors, lead right into the world of Behavioral Economics.
To start, the human brain has evolved to create certainty and order. We do not like to think that chance plays a part in outcomes. Humans have survived because they have made order out of chaos. Our brains evolved to do this — to seek certainty. Uncertainty wreaks havoc on our brain and emotions.
Wall Street has recognized this human need for decades. Wall Street marketing wants us to believe that investing is like chess. In chess there is certainty — a correct answer for every move. It may not be known by a player during a game, but it exists. This is why AIs can be created to play unbeatable chess games.
Wall Street firms produce volumes of data every day in an effort to make investors think they know the future, that they create certainty out of chaos. Many investors dig this and crave for it. It feeds their need for order. The problem is, however, that evidence shows the Wall Street prognosticators are consistently inaccurate. Nobody knows nothing.
If an all-knowing investing algorithm existed, we would already be plugged into it.
Closing
In reality, investing is more like poker.
“Poker…. is a game of incomplete information. It is a game of decision-making under conditions of uncertainty over time …valuable information remains hidden. There is also an element of luck in any outcome. You could make the best possible decision at every point and still lose the hand.”
Having a well thought out decision based model can lead to a good decision process. This is the best you can do in an uncertain world. This is how the best poker players succeed. They have good decision processes. They don’t win every hand; that is impossible. But, over time, they win the most money. They don’t let “resulting” effect their long term goals.
In the end, our financial outcome will be like a game of poker; the sum of decision quality plus luck.
Cheers.
I like the poker-investing parallels, they teach so much, as do Thinking in Bets, and You bet.
And of course, playing poker!