Last Updated on June 19, 2022 by Quantified Trading
In the stock market, and especially in trading, it’s easy to fool yourself. The famous scientist Richard Feynman once said that the first principle is that you must not fool yourself and you are the easiest person to fool. Trading involves decision-making all day long, and decision-making ends with a good or bad outcome.
Unfortunately, we don’t know the outcome when we make our decision but tend to confuse the quality of the decision with the outcome (good or bad).
Most people tend to rank their decisions on the outcome: A good outcome is a result of a good decision, and a bad outcome is based on a bad decision. We judge the quality of our decisions on the outcome, not the other way around.
But you can have a good outcome despite a bad decision, and you can have a bad outcome even though the quality of your decision was good. This is what Annie Duke calls “resulting” in her book called Thinking In Bets.
What is Annie Duke’s Thinking In Bets about?
Annie Duke was (is?) a professional poker player. However, the link between poker and trading is pretty obvious for those who have tried both. The crux of Duke’s book is poker but that doesn’t really matter. The book is all about how to make better decisions, be it everyday life, business, marriage, behavioral studies, etc.
The book is a typical Charlie Munger book and he has mentioned the book on several occasions. Annie Duke uses poker as a metaphor throughout the book to illustrate how to think in bets and the uncertainty embedded in any outcome. We do ourselves a disservice by focusing on the outcome. We can’t control the outcome – we can only control the decision process.
Because decision and outcome are highly likely correlated in the long run, you need to look more deeply at the former. Doing this with persistence will get you about as far as chance will allow, just as Munger would say.
We all fall prone to the resulting bias
Take a moment to reflect on your best decision during the last year. Likewise, spend some thinking about your worst decision. Annie Duke argues that the best decision preceded a good result and the worst decision preceded a bad result.
However, that’s because we judge our decisions by “resulting”.
A good decision sometimes results in a bad outcome, and a good outcome can happen after a bad decision. We often fool ourselves by judging the quality of the decision based on the end result.
If you have a resulting bias, you’ll have problems learning from your decisions. To avoid “resulting”, you need to focus on the decision process.
Why is it important to think in terms of “bets”?
Life is a perpetual state of learning. Experience is an effective teacher but only if you are willing to listen. Even just small deviations make you go completely astray over the long term.
Think about a ship that is crossing the Pacific but the compass is one degree off the mark. Over such vast distances, even such a small mistake will make you miss your destination by a wide margin.
Likewise, both in life and trading the same applies: just tiny improvements will make you much better off in the long run!
The two sentences below summarize the book pretty well:
Be agnostic, adaptive, open, truthful to yourself, and a student for life. This should compound both knowledge and wealth.
Annie Duke Thinking In Bets the main takeaways
Below is what I consider the main takeaways from the book:
- Make sure you have a rational framework for your decisions.
- All your decisions should be done in a way as if you are betting all of your money on your choice.
- Be aware of your trading biases and look for contrarian opinions.
- Don’t take shortcuts.
- Don’t blame bad luck on bad outcomes; don’t pat yourself for good outcomes unless a good decision.
- Use the feedback loop to look back at your decision process. What could be improved? This is where a trading journal comes in handy.
- Rinse and repeat.
- Life is a perpetual state of learning, and learning compounds over time.
- You learn the most by having skin in the game via betting. Ask yourself: How much do I want to bet on this outcome?
- Be truthful to yourself and find knowledgeable people that sometimes disagree with you. If you are wrong, it means you go to bed wiser.
Annie Duke’s backcasting and premortem
Another important topic in Annie Duke’s book is backcasting and premortem.
Backcasting is when you start looking back from your imagined endpoint after a positive endeavor. For example, you look at yourself as a successful trader ten years in the future and you write down reasons and plans on how you ended up successful.
The opposite, when you look back after a negative experience, Duke calls these premortems. This might be a bit similar to postmortems where a medical examiner determines the cause of death (after it has happened). A premortem is an equally bad investigation (as you end up unsuccessful), but before it happens. How did you end up as an unsuccessful trader? How did you end up miserable?
Annie Duke argues we are generally biased to overestimate the probability of good things happening. We imagine ourselves as successful traders, even though most of us fail. Being positive is in general a good trait, but being realistic and rational are not bad either.
What’s the point of backcasting and premortems?
If you imagine your obstacles to get to your goal, you are better prepared to avoid and circumvent those obstacles.
The negatives of Annie Duke’s Thinking In Bets
Just like most books the book could easily have been cut down 30% without missing anything important. Some parts are repetitive and unnecessary.
Quotes from Annie Duke’s Thinking In Bets
Below are the most interesting takeaways and quotes from Thinking In Bets.
Mistakes, emotions, losing – those things are all inevitable because we are human. The approach of thinking in bets moved me toward objectivity, accuracy, and open-mindedness. That movement compounds over time to create significant changes in our lives.
We are discouraged from saying “I don’t know” or “I’m not sure”. We regard those expressions as vague, unhelpful, and even evasive. But getting comfortable with “I’m not sure” is a vital step to being a better decision-maker. We have to make peace with not knowing.
What makes a great decision is not that it has a great outcome. A great decision is the result of a good process, and that process must include an attempt to accurately represent our own state of knowledge. That state of knowledge, in turn, is some variation of “I’m not sure”.
In fact, believing is so easy, and perhaps so inevitable, that it may be more like involuntary comprehension than it is like rational assessment.
It turns out the better you are with numbers, the better you are at spinning those numbers to conform to and support your beliefs.
“Wanna bet”? Suddenly, you are not so sure. That challenge puts you on your heels, causing you to back opp your declaration and question the belief that you just declared with such assurance.
We are in a perpetual state of learning, and that can make any prior fact obsolete.
Given that even scientific facts can have an expiration date, we would all be well-advised to take a good hard look at our beliefs, which are formed and updated in a much more haphazard way than those in science.
Experience can be an effective teacher. But, clearly, only some students listen to their teachers. The people who learn from experience improve, advance….
Experience is not what happens to a man; it is what a man does with what happens to him.
Why did something happen the way it did?
And the first step to doing well is recognizing that things sometimes happen because of the other form of uncertainty: luck.
Just as we are almost never 100% wrong or right, outcomes are almost never 100% due to luck or skill.
Self-serving bias is a deeply embedded and robust thinking pattern. Understanding why this pattern emerges is the first step to developing practical strategies to improve our ability to learn from experience.
My biased assessment of why they were winning slowed my learning down considerably. I missed out on a lot of opportunities to make money because I dismissed other players as lucky when I might have been learning from watching them.
Luckily, habits can be changed, whether the habit is biting your nails or decrying your terrible luck when you lose.
The prospect of a bet makes us examine and refine our beliefs, in this case the belief about whether luck or skill was the main influence in the way things turned out. Betting on what we believe makes us take a closer look by making explicit what is already implicit: we have a great deal at risk in assessing why anything turned out the way it did. That sure sounds like a bet worth taking seriously.
The benefits of recognizing just a few extra learning opportunities compound over time…..If the ship’s navigator introduces a one-degree navigation error, it would start off as barely noticeable. Unchecked, however, the ship would veer farther and farther off course and would miss London by miles, as that one-degree miscalculation compounds mile over mile.
Having the help of others provides many decision-making benefits, but one of the most obvious is that other people can spot our errors better than we can.
Diversity and dissent are not the only checks on fallibility, but the only means of testing the ultimate truth of an opinion.
If we’re going to improve our beliefs, we’ll be better off if we include people and information sources we’re likely to disagree with.
The best way to do this is to deconstruct decisions before an outcome is known.
Yet true skepticism is consistent with good manners, civil discourse, and friendly communications….Skepticism is about approaching the world by asking why things might not be true rather than why they are true….And we need to be particularly skeptical of information that agrees with us because we know that we are biased to just accept and applaud conforming evidence….Don’t say: “You are wrong”! Say, “are you sure about that?”…Organized skepticism invites people into a cooperative exploration.
Improving decision quality is about increasing our chances of good outcomes, not guaranteeing them. Even when that effort makes a small difference – more rational thinking and fewer emotional decisions, translated into an increased probability of better outcomes – it can have a significant impact on how our lives turn out. Good results compound.
When we make in-the-moment decisions (and don’t ponder the past or future), we are more likely to be irrational and impulsive.
Saving for retirement is a temporal discounting problem: the gratification of spending discretionary income is immediate. Putting it away for retirement means we have to wait decades to get enjoyment from that money….Subsequent studies have shown that the ability to delay gratification is correlated with markers of success throughout adolescence and into adulthood.
The way we field outcomes is path dependant. It doesn’t so much matter where we end up as how we got there. What has happened in the recent past drives our emotional response much more than how we are doing overall.
In relationships, even small disagreements seem big in the midst of the disagreement. The problem in all these situations (and countless others) is that our in-the-moment emotions affect the quality of the decisions we make in those moments, and we are very willing to make decisions when we are not emotionally fit to do so.
Anticipating the range of outcomes also keeps us from unproductive regret (or undeserved euphoria) when a particular future happens. Finally, by mapping out the potential futures and probabilities, we are less likely to fall prey to resulting or hindsight bias.
Backcasting (looking back from a possible end result) reveals the positive space. Premortems reveal the negative space.
Oettingen recognized that we need to have positive goals, but we are more likely to execute on those goals if we think about the negative futures.
We form beliefs in a haphazard way, believing all sorts of things based just on what we hear out in the world but haven’t researched ourselves… Gilbert and colleagues demonstrated through a series of experiments that our default is to believe that what we hear and read is true. Even when that information is clearly presented as being false, we are still likely to process it as true.
Truthseeking, the desire to know the truth regardless of whether the truth aligns with the beliefs we currently hold, is not naturally supported by the way we process information.