Google Talks: Thinking in Bets

"There are only two things that determine the way our lives turn out - luck, and the quality of our decisions. We can't really control the luck element, so we might as well get really good with the quality of our decisions." - Annie Duke

"The biggest risk is that you have a losing strategy when you think you have a winning one." - Jeff Yass, Founder of Susquehanna Intl. Group

I had the privilege of watching Annie Duke's seminar about "Thinking in Bets" - also the title of her book, about employing probabilistic thinking, and overcoming personal bias in our decision analysis.

If you get the chance, I can't recommend watching it highly enough - https://www.youtube.com/watch?v=uYNsSeYjkp4.

Annie was a professional poker player, and World Series of Poker bracelet winner. She's now an author and advisor in the corporate world. Her focus is primarily in assessing how people make decisions under pressure, in uncertain conditions. Sounds familiar, right?

So what is a bet exactly? It's a decision about an uncertain future (with an obvious risk/reward). The problem is, as humans, we employ all sorts of personal biases that have significant implications on our thinking. Her work helps one to avoid common "decision traps," and develop one's outcome-processing routines, so you can maximize your ability to learn from mistakes.

Thinking in bets forces you into a more probabilistic mindset. For instance, you might say, "I think it's going to rain tomorrow." However, if you said it was going to rain, and I responded, "want to bet?" You would likely backpedal, and consider all the alternatives before basing your final decision. "It causes you to retreat from a place of certainty, to a place of probability," in which you truly address the degree of uncertainty, and causing you to be considerably more open-minded.

One of the core principles she references is called "resulting" - or associating the soundness of one's decision making process with the results. For example, say you took a gut-shot trade (on pure instinct) and ended up making a killing, you might look back on this experience and think it was brilliant (when in reality it was entirely due to luck). Contrarily, you might also take a loss where you'd put in a significant amount of planning, and decide to change your methods (despite having made the right choice). She also discusses how we are bred (from an evolutionary standpoint) to favor false positives. For instance, if you were a caveman in the savannah, if you hear rustling in the bushes, it's better that you run (even if it's just the wind), than to stand there and be eaten; this is known as a Type I error. Concurrently, it's much less favorable if you were to hear rustling in the bushes, but ignore it, and be summarily eaten by a lion (a Type II error). Resulting denotes part of our "natural state" and unless we commit to fostering accurate, unbiased analysis, our interpretations may often land us on the "dinner table."

Think about it this way. As traders, we are making hundreds of decisions per trading day. When you enter a trade, you are making a decision, regardless of whether it was taken on gut instinct, or calculated analysis. This decision is a bet, and you are essentially betting against the person on the other side of your trade (as well as the alternative-you that would have otherwise stood aside, or countered). Your stop loss is also a decision, as well as whether you decide to hold, cut loose, add, or whatever. If you are disregard analysis just because a trade worked out, you are assuming that you didn't make any mistakes, and are foregoing the opportunity to learn from it. By the same token, if you take a losing trade, and you forego the opportunity to analyze the trade, you might discover that you actually made a good call, which might prevent you from changing your strategy (a common cycle for new traders).

So, consider you made a trade, and you end up taking a loss. What should your next step be? One technique she recommends is utilizing your peers, in order to gauge the strength of your decision. However, rather than telling them what the result of the trade was, she suggests that you give them all the information, up to the point where your decision took place (because once they know the outcome, it's considerably more difficult to give an unbiased opinion). Concurrently, she discourages "infecting the other person" with your beliefs, meaning you do not want color the person's interpretation by telling them what you did. For me, it means sending my mates a screenshot of the preceding price action and the entry-bar, but take off my order markers, and simply ask, "what would you do here?" That way, you can get a genuine, unbiased opinion from your peers, and use that feedback to help refine your process.

Duke alludes a variety of different biases that affect our decision making process. For instance, we all have a tendency toward confirmation bias, in which we commonly see evidence that supports our position (also known as "motivated reasoning"). I can't tell you how many times I've heard someone say, "The market looks like it's going to stall; divergence on the MACD; volume is starting to weaken - it's definitely going to drop," just to have the market bust through a resistance level and make a higher high. Adding insult to injury, she stated that people with high IQ's are actually more prone to motivated reasoning, because if you are "cognitively agile" you are going be much more capable of breaking down the data so it caters to your narrative.

As traders, many of us look at our results on a trade-by-trade basis. Meaning, we often form conclusions about the validity of a decision based on a singular trade. This fallacy was also alluded to by Mark Douglas in "Thinking in the Zone," in that, "it only takes one, motivated person in the world to botch your entire premise." That's why we need to look at our trade performance as an aggregate, but most of us aren't very good at doing so. That's why it's imperative that we learn to properly analyze and reflect upon our decision making process, so we don't fall victim to common misconceptions (and ultimately keep making the same mistakes for months or even years on end).

As humans, we are also prone to self-serving bias, meaning that (when we win) we are more likely to credit our successes to skill, rather than luck. Ultimately, we all want to drive the positive narrative in our lives, and are commonly influenced by this self-serving bias. Concurrently, we often have difficulty facing our losses, having a tendency to credit our losses to bad luck, rather than the skill of our opponents. For instance, she states that over 90% of two-car accidents are reported as the other person's fault. Clearly, this illustrates humans' inaccurate reasoning when reflecting upon their decision making progress.

She suggests we can transform our thinking, training ourselves to feel good by:

-Giving credit to someone for beating you

-Being good about admitting mistakes

-Being good at finding mistakes in positive outcomes

-Being a good learner (and by result, a good decision maker)

Contrarily, instead of wanting to offset your loss to bad luck, you might adopt a mindset where you feel badly for missing a learning opportunity (or for basking in elation after the win, rather than looking at room for improvement). We can train ourselves to start thinking this way, and with due diligence, it slowly becomes habit.

In order to vet your decision making process, Duke suggests forming a "truth-seeking group" - a community dedicated to uncovering unbiased, and accurate analysis. The reason being, it's much easier to see someone else's bias, rather than see your own bias, and through partnership, you can help to hold one another accountable. There are three principles she recommends the group adhere to, including:

1) A commitment to accuracy (meaning unbiased, realistic interpretations).

2) An openness to diverse viewpoints.

3) Holding one another accountable.

She also recommends meeting once a week (as a group) sharing the best success they had that week, as well as 5 things they did wrong leading up to that success. Over time, once you develop a solid rapport within your truth-seeking group, you will start to "hear" the voices of your group members before making your decisions. You might also pose neutral-questions about the market to your group members (if you are considering entering a position) by asking, "What do you think will happen next?" the reason being, if you tell the person what you think is going to happen, you are going to influence their interpretations.

Being selective with your decisions is also an important element she attests to, so - rather than throwing spaghetti at the wall, and hoping something sticks - you want to look at each strand of spaghetti, so to speak, and make sure that you're getting a payoff. You might consider using decision trees to go back and look at the quality your decision making process. Although they are likely too time consuming to utilize for a scalper, or high frequency trader, if you are an options trader, investor, or swing trader, I think it's a fantastic tool to help break down the possible outcomes and their associated payoffs.

In summary, if we can utilize these techniques in order to vet our decision making progress, out of the 200 decisions we might make during our trading day, if we can catch just 10% more, then we are going to outperform our opponents that are taking no such action. "The way that we preface information is so built in, that the goal is just to be a little bit better about it. If you're a little bit better about it, then it's going make a difference in your decision quality, and the quality of your outcomes over time."

I hope you found this both helpful, and insightful, and if we can [collectively] catch 10% more mistakes than our peers, I have no doubt that it bodes well for the future.