Moontower #66

Friends,

Thinking Like a Trader

Robin Hogarth would call investing a “wicked” learning environment. Information is hidden in such a way that we struggle to identify causality. I contrast investing a bit with trading and games which are fertile ground for reasoning, probability, and logic. With large enough samples, you get tighter feedback loops, a critical input to learning. I don’t know much about digital marketing or Google AdSense but my guess is market-making has more in common with SEO than it has with buy-and-hold investing.

Because of my interest in topics like learning, reasoning, and money matters, I sometimes have younger readers ask me how to “think like a trader”. I’ve pointed to some places in the past.

• A few months ago I shared the books I’ve crowdsourced from traders: The Investing Pros Library (Link)
• I’ve narrowed a list to target beginners in particular. (Link)
• A collection of resources to teach kids business. (Link)

While these are all useful, the single best way to adopt a trader mindset is to do what Annie Duke recommends:

Think in bets.

Betting is really about decision-making.

Every decision you make is actually a bet that the chosen action is better than all the alternative options. Annie’s recent book Thinking In Bets is about making better decisions when you don’t have complete information. Making better decisions is so obviously important living a happy life it feels silly to even state that. Naval Ravikant says that good judgment is the most important attribute of anyone with a high leverage position like a CEO. Or the director of NIAID. If the impact of a decision is levered 10x, then a 1% better decision is an order of magnitude more valuable than the inferior one.

We spend years learning formal grammar or cherry-picked history yet most of our decision-making skills come from trial-and-error. In a complicated world where causality is opaque and noise is abundant, it’s simply too easy to learn the wrong lessons. Look around. The post-hoc fallacy is everywhere. “Since event Y followed event X, event Y must have been caused by event X.” You took an herb and your cold went away. Must have been the herb. You played video games when you were a kid, and now you have a good job. I guess Halo was good job training. There are many outcomes that people say are attributable to X when it could be even more likely that the outcome was in spite of X. Your reason for something could be the exact opposite and you don’t even realize it.

Michael Mauboussin, during a 2019 talk, said:

The best probabilistic decision-makers have more in common with each other than with the average decision-maker in their profession…Warren Buffett has more in common with Annie Duke than he has with the average investor. (Link)

Betting As ‘Decision’ Practice

A strong trading education will include an explicit education in decision-making. Markets become the proving ground for that education.

Marc Andreesen in a recent (and rare) interview:

One of the things you find about professional gamblers – they may play poker at night but what they do during the day is they hang out together and they make side bets for large amounts of money. And it’s literally a side bet of sitting in a diner and betting on whether there are going to be more red cars than blue cars passing by. What they’re doing is ‘steeling’ their own psychology to be able to pull the trigger on bets like that with a purely mathematical lens and with no emotion whatsoever. They’re trying to steel themselves to be able to be completely clinical. And so as contrast, what they then hope for that night when they sit across the table from someone is to hope they’re dealing with somebody who’s super emotional. Because the clinical person is going to just slaughter the emotional person. (Link)

I’d respectfully edit this line: “They’re trying to steel themselves to be able to be completely clinical.”

Actually, they just think they have an edge. The byproduct of that betting process is the “steeling”. This loops until they are quite clinical about the risk. This was the nature of trader training. There were many hours of poker hands and mock-trading deconstructed. Bets are hypothesis tests. The constant feedback calibrates how you map future hypotheses to future situations. Betting is a practice that tightens that loop.

In contrast, big decisions in life are hard because we don’t get much practice at them. You don’t get a lot of reps when it comes to picking a spouse (Elizabeth Taylor notwithstanding).

Ways to Learn More About Decisions

I recommend Annie’s interview with Ted Seides on his pod. I thought it stood out in the sea of “behavioral” content. I jotted some notes to jog your memory on key points. (Link)

If you agree that decision-making is a discipline that should be explicitly taught you’ll be pleased to hear there’s an organization called the Alliance for Decision Education. Its board and advisors include many notable backers including Mauboussin, Annie Duke, Prof. Daniel Kahneman, author Brian Portnoy, and several former Susquehanna execs including a founding partner. Learn more about their mission to spread decision best practices. (Link)

Caveats

• I didn’t read Duke’s book despite really enjoying the pod.

  The content was the air I breathed in training. The principles would be a refresher for sure but hard to prioritize when I struggle to make it through my existing book queue.

• There are diminishing returns to studying decision-making explicitly vs just practicing.

  Kahneman himself doesn’t think the awareness of bias inoculates you from it. I don’t fully agree. Naming the biases provides you with the red challenge flags to throw in the moment. I’ve had enough discussion about trades to see the value in surfacing the subliminal. To the extent that we still make mistakes and always will, Kahneman’s point is well-taken.

• There are many schools of thought.

  Naturalistic decision making is championed by Gary Klein. The ergodicity crowd led by Ole Peters thinks many of the so-called behavioral biases like ‘risk aversion’ are an artifact of the assumptions baked into studying how people decide in contrived lab settings. There’s a lot of brain damage to be had if you dig. This doesn’t even get into more common sense questions: the limits of transferability. Are poker players actually good decision-makers away from the table?

• A final point (and partial confession).

  There is nothing more insufferable than a trading trainee. They are so eager to tell you what decision bias you are falling for. It’s like people who just learned about nutrition or exercise commenting on your form or what you are eating for lunch. You want to chase a Pop Tart with a glass of Fruit Loops milk in front of their bulging eyes just to spite them.

  We don’t need people leaning into crappy decisions because you come off like a pedantic hack.

The Money Angle

I mentioned that trader training included playing games and mock-trading. If you want a glimpse of what mock trading options was like, check out my recent post:

Mock Trading Options With Market Makers (Link)

If you’d like to try your hand at mock-trading futures or options with your friends or family here’s a game we used to play in either group interview settings or with brand new trainees.

You Can Mock Trade With A Deck Of Cards (Link)

Last Call