Behavioural Finance and Poker

[davebytheway]

Slate.com right now has an article by Henry Blodget (the disgraced former tech analyst) on why people aren't as good at investing as they think they are. It discusses a number of psychological issues currently grouped together under the theme of 'behavioural finance'.

The excerpt below from the article gives a list of common behavoiural issues. What struck me is the way that these issues relate to poker: whether through bankroll management, analysis of past and current play, and expectations of future results. I know that I personally suffer from some of these behavoiural patterns.

Thoughts?


(Article Excerpt) Issues:

Self-attribution Bias: We attribute our successes to ourselves, and we blame our losses on others or bad luck. This hobbles us in two ways. First, we don't learn from our mistakes because we don't see them as mistakes. Second, we assume we are skilled or smart when we're just lucky.

The Gambler's Fallacy: We tend to believe, incorrectly, that if a flipped coin has come up heads three times in a row it is more likely come up tails next time. Similarly, just because a stock or market has gone up or down for a while doesn't mean it is more likely to go the other way soon.

Prospect Theory: We have an irrational tendency to sell our winners to lock in profits and keep our losers to avoid taking losses. This causes us to sell too early when the market is going up and too late when it is going down. We also feel the pain of loss more than the pleasure of gain and, therefore, blow out losing positions in panic when we should just hang on.

Conservatism Bias and Confirmatory Bias: Once we form opinions, we tend to overvalue information that reinforces them and undervalue information that undermines them (conservatism bias). We even tend to seek out supporting information (confirmatory bias). Thus, we irrationally cling to incorrect conclusions, and, to paraphrase Simon and Garfunkel, hear what we want to hear and disregard the rest.

Overoptimism: We tend to be overoptimistic and overconfident. According to James Montier, when students are asked whether they will perform in the top half of their class, an average of 80 percent say yes. This tendency makes it easier for part-time hobbyists to dismiss a century's worth of academic research showing that only a tiny fraction of full-time professionals can beat the market.

Outcome Bias: We tend to evaluate decisions based on outcomes instead of probabilities. Thus, we congratulate ourselves for stupid choices that happen to turn out well and vow to never again make smart choices that happen to turn out badly. Our errors get reinforced, and our wise decisions rejected.

Buffett's "Rearview Mirror": We base our expectations for the future on what has happened in the recent past. Thus, we are most bullish at the end of long bull markets, when we should be most bearish, and most bearish at the end of long bear markets, when we should be most bullish.

Hindsight Bias: When we reflect on the past, we imagine that we knew what was going to happen when we didn't. As James Montier puts it, "You didn't know it all along, you just think you did." This allows us to imagine, for example, that we knew that the tech boom of the late '90s was a bubble and that everyone who suggested otherwise was an idiot or crook. It also makes us overconfident about our ability to predict what will happen next.

[Bodhi]

All of what you write is true. What a lot of these cost/gain rational choice type theories tend to avoid, however, is the very real and profound ability of individuals to engage in rampant self-deception. Ultimately, self-honesty is what is required of a good investor or poker player. But being able to apply empirical psychological research to oneself and his choices only gets him half-way there.

[Fast_Johnny]

[ QUOTE ]

The Gambler's Fallacy: We tend to believe, incorrectly, that if a flipped coin has come up heads three times in a row it is more likely come up tails next time. Similarly, just because a stock or market has gone up or down for a while doesn't mean it is more likely to go the other way soon.

[/ QUOTE ]

What about the theory of "Returning to the mean" We all know cards averge out in the long run. If your on a particularly bad run of cards, they will have to average out at some point. I read this in a general gambling book somewhere. The Author went on to say that no matter what happens probabilities are probabilities regardless of what has happened.

[MicroBob]

You are making a horrible error in logic here (albeit an incredibly common one) that is addressed correctly in the article and also has been discussed SEVERAL times on these forums.


In the long-run, things will gravitate towards the mean.
After a zillion hands you will have gotten AA the requisite 1-on-220 times.
But you can't do it backwards....just because you have NOT gotten AA in your last 500 hands does not mean you are any more or less likely to get on the next hand dealt.The cards don't know that you haven't gotten AA in the last 500 hands.

Contrarily, if you have received AA on 3 of your last 5 hands that does NOT mean that you will not get it again in your next 600 hands because you have "already met your average" or something.
The odds of getting AA on the next hand remain at 1-in-220.
The odds of getting it the hand after that and the hand after that and the hand after that will ALL be 1-in-220.


you HAVE to understand this or else I would argue it would be virtually impossible to be a winning poker player.



The article itself is OUTSTANDING.
I'm forwarding it to my Dad who is a succesful investor (and has the numbers to prove it BTW) and enjoys looking at the similarities between what he does and what I do.
Even though he doesn't even know how to play poker he knows that they are the same in many ways.

[MicroBob]

[ QUOTE ]
Self-attribution Bias: We attribute our successes to ourselves, and we blame our losses on others or bad luck. This hobbles us in two ways. First, we don't learn from our mistakes because we don't see them as mistakes. Second, we assume we are skilled or smart when we're just lucky.

[/ QUOTE ]



What's interesting is that i believe I tend to do the exact opposite of this much of the time.
When I go on a winning rush I generally consider myself to have gotten REALLY lucky and I always suspect that I still didn't get the bets that I should have.
What's more, I'll sometimes think that I would not have won as much as I did if I hadn't been such a LAG.

When I lose, I usually feel like I played badly and got schooled by a couple of opponents. I'll blame my skill even when I know that the bulk of my losses came on typical 2-outers on the river.


My feelings either way are not so extreme that it gets in the way too much.
If anything, I believe it is a positive trait in that it constantly instills the notion that I need to keep working.

[Rudbaeck]

[ QUOTE ]
What about the theory of "Returning to the mean" We all know cards averge out in the long run. If your on a particularly bad run of cards, they will have to average out at some point. I read this in a general gambling book somewhere. The Author went on to say that no matter what happens probabilities are probabilities regardless of what has happened.

[/ QUOTE ]

I catch myself doing this all the freaking time when playing BJ to clear some bonus. If I'm down a small voice starts insisting that I should bounce back as the mean loss isn't as big as my temporary setback. I know this is utter lunacy, but the little voice is still there!

Luckily the little voice has learnt to stfu when I play poker.

[FlFishOn]

Wow. Very nice. Worth the price of admission all by itself.

[CraigNYC]

The Gambler's Fallacy: We tend to believe, incorrectly, that if a flipped coin has come up heads three times in a row it is more likely come up tails next time. Similarly, just because a stock or market has gone up or down for a while doesn't mean it is more likely to go the other way soon.

Buffett's "Rearview Mirror": We base our expectations for the future on what has happened in the recent past. Thus, we are most bullish at the end of long bull markets, when we should be most bearish, and most bearish at the end of long bear markets, when we should be most bullish.

[/ QUOTE ]
Aren't these two theories in confilct with one another? Am I misunderstanding something? I am wondering if the "Gambler's Fallacy" does not really apply to the stock market. Because financial markets are known and proven to be cyclical. Anyone aggree/disagree?

[bdk3clash]

I posted about this article on my blog; not much to add, other than to say it's really good and worth reading for anyone who takes gambling and/or investing seriously.

[Monty Cantsin]

Very nice. Reminds me of this little beauty: Charlie Munger on the Psychology of Human Misjudgement.

/mc