I suppose I should have given the background of this experiment.Originally Posted by Freightman
In March, 1979, two Israeli psychologists published an article that rocked the field of economics. Previously, economists assumed that humans were, for the most part, rational beings who weighed value and probability to maximize their "utility." The two psychologists suggested that this was not just overly simplistic, but was simply wrong. Humans were not always rational. In fact, they were predictably irrational. Instead of deliberating within the laws of logic, people consistently use mental shortcuts, or "heuristics," which lead to systematic biases in how we make decisions under uncertainty.
In their famous paper, these two psychologists, Daniel Kahneman and Amos Tversky, proposed an alternative framework to model human decision-making, which they called "prospect theory." They focused on choices involving uncertainty, some between two possible financial gains, and others between two possible losses. As they wrote, for example, consider which of the following, A or B, would you prefer? Option A involves an 80% chance you win $4,000, but a 20% chance you win nothing. Option B guarantees you win $3,000 for sure.
If you're like the majority of participants in their study, you chose B. When it comes to gaining stuff, you prefer certainty over risk-taking, even if the expected value (e.g., value times probability) of the gamble is slightly higher. Now, consider you were at risk to lose money. Which of the following options, C or D, would you prefer? Option C involves an 80% chance you lose $4,000, but a 20% chance you lose nothing. Option D guarantees you will lose $3,000 for sure.
Although the amount of the losses and gains are the same, like the majority of people, you likely now chose C. Contrary to classical economic theory, our preferences aren't always so consistent: when it comes to losing we prefer risk-taking, but when it comes to winning we prefer certainty.
The original paper has since been cited almost 9,000 times, and Kahenman later won the nobel prize in 2002 for bridging the gap between economics and psychology (Tversky had died of cancer before the award was officially anounced). It also helped spur a tsunami of research, as psychologists and economists worked to elucidate the many other biases in everyday decision making. Today, almost 200 cognitive biases, fallacies, heuristics, effects, and illusions have been elucidated, comprising a whole new sub-field of psychology (which economists call "behavioral economics").
Still, many interesting questions remain in the field. For instance, between the negativity bias, optimism bias, overconfidence, and underconfidence, we tend to have a somewhat distorted view of ourselves. Whereas these biases at times can be useful, recentresearch shows that accurate self-knowledge is important for the quality of relationships. In what other situations is accurate self-perception important? And how can we improve accuracy when we want it?
In addition, although the hot hand fallacy has been studied extensively in sports (i.e., basketball players, for the most part, don't actually get "hot," we just mistakenly see patterns in randomness, particularly when it comes to streaks), few researchers have looked at how a sense of hot or cold hand, or momentum bias, may transfer across different activities or domains. In particular, after a streak of good or bad random events, to what extent do we develop an illusion of self-efficacy or a more generalized hot or cold hand beyond the change in our emotions? And what is stronger, the hot hand or the cold hand fallacy?
I originally read about this question in a paper that was talking about how people approach the stock market, which I am heavily involved in. So this is definitely not a one-time choice, but rather a recurring decision to be made in a constantly moving market. The lesson, in a nutshell, is that you are to "let your winners run" and "stop your losses short." It is meant to change one's investment philosophy which is so often wrong. Most people, as ZMF stated, attach emotion to their investing decisions. The emotion at hand is usually fear. They buy after the stock is already overpriced because they "fear" that they are going to miss out and they get in too late. When the stock inevitably drops, through fear again, they do not want to accept that they are going to lose so they continue to hold onto the stock. They will often however finally proceed to sell at the worst possible time. So "buy low and sell high" becomes "buy high and sell low," which is obviously the opposite of what one should do.
It would be an understatement to say that blackjack is a volatile undertaking. It takes so much trust and self-control. While the stock market is volatile at times, it is more "passive" from most people's point of view. They just "buy it and forget it." With blackjack, it is "active." An AP may have to helplessly watch as their bankroll diminishes week after week in a sudden turn of variance. Self-control is paramount in this situation. They must stick to the plan.
This is why one of my favorite investing weapons is the Married Put (hence my username). I like knowing that my potential gain is infinite while my potential loss is limited. After all, the only thing that I can 100% control in the stock market is how much I can potentially lose. I therefore like choosing investing instruments that give me this option.
I know that you are a smart guy Freightman, so all of this is probably pretty obvious to you. Hopefully my comments will help other readers out there as well though, lurkers included.
To answer your question though, I think it all comes down to preference. If it were a one-time choice, I would still go for the $4,000 win and the $3,000 loss, but that is just me. I like those odds. It would satisfy the part of me that wants to "gamble" while still giving me justification for my choice by knowing that I am still making the correct mathematical decision. However, would I still make the same decision if I added one, two, or more zeros to those numbers? Hmmm.....THAT question is even more fun!
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Play within your bankroll, pick your games with care and learn everything you can about the game. The winning will come. It has to. It's in the cards. -- Bryce Carlson
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