17 ms·

Don't bet on the most likely winner

149 points by avoidboringppl 6y ago

TMWNN 6y ago
"The race is not always to the swift, nor the battle to the strong, but that is the way to bet" —Hugh Keough
- thaumasiotes 6y ago
  Different context. If you're being offered the same odds on every bet, bet on the likely winner.
- MaxBarraclough 6y ago
  But it's not. From the article: > you want to bet on the mispriced horse, not the horse most likely to win
  - tsimionescu 6y ago
    If one horse is given 1:50 odds but should have been given 1:100, how many races would you have to bet on to make money on those odds?
    - mmmmmbop 6y ago
      Let's assume the odds are fair such that the odds of all horses sum up to 1. Betting on all other horses would give you 1:1.02 odds whereas they should have been 1:1.01. While there is no way to answer for sure how many races you would have to bet on to make money, we can look at the probabilities. There's a 95% likelihood that the horse will lose 5 races in a row. If you start with $100 and reinvest your winnings every time you'd earn a profit of $10 with 95% likelihood, meaning there's a positive expectation value. On the other hand, if the 1:50 odds were right, the probability of it losing 5 times in a row would be around 90%, leading to a neutral expectation value.
    - MCneill27 6y ago
      Except investing isn't like a horse race. Each horse has a different finish line, and those finish lines are in flux during the race. Crucially, you can change your bet in the middle of the race.
- chriswarbo 6y ago
  I think that misses the point of this article. More appropriate might be: "The race is often to the swift, and the battle to the strong, but the way to bet is on those with miscalibrated odds." If the odds are well calibrated, the expected return is zero; we might as well not bet. The same goes for speculating on well-priced assets. If we have reason to believe that the odds/prices are miscalibrated, we can expect a positive return by going long/short (depending on which direction they're off).
  - thaumasiotes 6y ago
    Well, the original quote is more about making plans. Georgia is at war with Russia: who will win? You can -- and people very much do -- try to set up a situation with a massive payoff for you in the unlikely event that Georgia wins. But the maxim is there to remind you that Georgia isn't going to win. Interacting with a bookie is a whole different context than interacting with reality.
    - Robin_Message 6y ago
      > Interacting with a bookie is a whole different context than interacting with reality. I think the point of the article was that interacting with the stock market (and potentially other areas of many businesses) is more like interacting with a bookie than interacting with reality.
      - thaumasiotes 6y ago
        Yes; I'm just saying I don't think the article's point detracts from the maxim.
    - chriswarbo 6y ago
      I'd still say it's not the likelihood or the payoff which matters, it's the expected return. If the payoff is massive enough to overpower how unlikely it is for Georgia to win, then it's worth setting up. It's also worth setting up situations which pay off if Russia wins, and the higher likelihood of that outcome should make us accept situations with lower payoffs in that case. I can think of a few reasons not to follow this strategy: - If our uncertainty is too high, we might want to avoid the risk; e.g. even if Georgia wins, we might not get anything out of it. - If the commitment is too high, e.g. a Martingale. - If setting up one outcome puts another at risk; e.g. if we fund Georgia's war effort, such that Russia would retaliate if they win; or the other way around; or both!
- jorangreef 6y ago
  That's a nice riff on the original: "Again I saw that under the sun the race is not to the swift, nor the battle to the strong, nor bread to the wise, nor riches to the intelligent, nor favor to those with knowledge, but time and chance happen to them all." —Ecclesiastes 9:11 To understand where Ecclesiastes is coming from: In the wisdom literature, books like Proverbs will typically state the common case and it's Ecclesiastes that will state the exception. This keeps the wisdom literature balanced as a set of principles, not rules. The Hugh Keough quote is a great summary then of the main point, which I won't restate.
fancyfredbot 6y ago
A nice post! The initial part of the article with the efficient markets hypothesis (satellite data and app download data are table stakes for investing) rings a bit hollow for me in a world where bankrupt Hertz is seeing its share price go up though...
- QuesnayJr 6y ago
  If you sincerely think that Hertz is overvalued, why don't you short it? It seems like an easy money-making opportunity, if so.
  - haakonhr 6y ago
    Not if they don't believe that the markets are efficient. It doesn't matter if you are, in some sense, "right" if the market disagrees. Wirecard is a prime example of this: a lot of short-sellers that, in the end, were right about the fact that it seems to have been a house of cards lost a lot of money.
  - fancyfredbot 6y ago
    Because the market can stay irrational longer than I can stay solvent
  - eru 6y ago
    Unfortunately, it's not that easy. The regulatory environment is not kind to short sellers. Matt Levine's Money Stuff often has examples of how shorting can go wrong. Recently there was a company that was accused of fraud. An obvious target for shorting. But: once the fraud properly came to light, the authorities promptly halted trading in the company's stock. After trading was halted, the shortsellers could not cover their shorts. And of course, in order to shortsell, you always need someone willing to lend you the stock in the first place. In the case of Hertz, https://fintel.io/ss/us/htz https://fintel.io/ss/us/htz does suggest that plenty of shortselling is going on. But https://finance.yahoo.com/news/why-bankrupt-hertz-short-squeeze-173507444.html https://finance.yahoo.com/news/why-bankrupt-hertz-short-sque... suggests that finding Hertz stock to borrow became harder over time.
  - 6y ago
AznHisoka 6y ago
I disagree somewhat with #1. Long Amazon, short JCPenney is an example of an obvious trade the past 5 years. Or even the past 2 years. Same with long Apple in 2012 when iPhones were ubiquitous. And you would have obliterated the index with those trades. Sometimes you don’t need an edge. sometimes the most obvious idea is the most profitable. And my theory why is because if it’s obvious, it’s because everyone else is in love with the idea as well and putting money into it. And in the financial world, people don’t just put money into it once. They add on to it month after month after month. So you don’t necessarily need to be early to profit well. Let the big trend appear, then invest big into it once it becomes clear as day. Because huge trends last longer than you think.
- dannyw 6y ago
  Specifically, there is a style of investing called “trend following” or “momentum” where you literally just buy things that are going up, and sell things that are going down. This works wonders and has been a constant source of factor alpha.
  - eru 6y ago
    They have been a reasonable source of alpha some of the time. But not a constant source all the time: trend following can badly go wrong. And, of course, because so many people do trend following these days, trend following itself will work less well in future.
  - r_singh 6y ago
    Identifying these "things" (assuming you're talking about options/futures) and getting the timing right is the hard part.
- swyx 6y ago
  as someone who was in a hedge fund shorting JCPenney in 2015, let me assure you that it wasn't "obvious". jcp was one of the most shorted companies in the entire world, its valuation was already low, and if it saw any real turnaround (as was hoped when they hired their ceo from Apple) all the shorts would have been obliterated. careful when you armchair quarterback with literal 2020 hindsight.
hamilyon2 6y ago
I don't know, this > It's how the stock performs relative to expectations that determines whether you make above average returns or not. is like, investment 101 knowledge. Anyone who ever came near managing a portfolio understands that.
taneq 6y ago
Well yeah, you want to bet on undervalued horses, not just fast ones. Likewise with stocks, it's hard to argue that Tesla isn't doing well, but you'd be bonkers to buy their stock right now.
- bjarneh 6y ago
  > but you'd be bonkers to buy their stock right now. You're probably correct; but didn't people say that when they went above $200 as well?
  - huffmsa 6y ago
    Yeah I've been hearing that basically since the IPO. Has yet to payoff.
    - OJFord 6y ago
      Too much FOMO and not enough 'I'd be bonkers to' - for as long as that's the case it pays to follow the FOMO! (Not investment advice I'm willing to follow myself! But a comment elsewhere in this submission, and a recent Levine column, have discussed that.. yeah, basically following the trend works... I suppose it shouldn't be that surprising, add more signals and act more quickly and you've reinvented a successful industry/form of professional trading.)
  - eru 6y ago
    Yes. In general, you should only invest in individual stocks, if you know something that the market doesn't know. Otherwise, just buy the most boring and low cost index fund you can find.
  - virgilp 6y ago
    OTOH, it's a generally a bad idea to invest in a company when the primary owner & CEO looks at the stock price and tweets "LOL". I feel it'd be a rational decision to short TSLA now except that "markets can stay irrational longer than you can stay solvent". And also I like Tesla, don't want to short it :)
  - 6y ago
jakozaur 6y ago
It's contrarian article: 1. In many tech area: networks effects and zero marginal costs creates winner(s) take all. In that sense it make sense to follow the winners as previously investors underestimated how big winner could be (e.g. Amazon, Google, Facebook, Apple). 2. Everywhere else: betting on underdogs that are mispriced is much better strategy in long-run. See Warren Buffet got huge returns by looking at fundamentals, but his strategy would not work well in tech.
- fancyfredbot 6y ago
  I think the point was not that you should invest in Yahoo (for example), it was that you should only invest in Google if it is underpriced.
  - ptero 6y ago
    In many cases in tech knowing something is underpriced is only possible after underpricing is gone.
- baxtr 6y ago
  Exactly. Because if not, why isn't bing on par with google by now?
  - Retric 6y ago
    Bing does seem to be on a slow upward trend: https://www.statista.com/statistics/216573/worldwide-market-share-of-search-engines/ https://www.statista.com/statistics/216573/worldwide-market-... It’s still only 6% of global search vs 86% for google.
    - kohtatsu 6y ago
      I wonder how much of that is from dark patterns in Edge.
      - stormdennis 6y ago
zuhayeer 6y ago
Looking at everything as relative to each other is a slippery slope to zero sum mindset. Are things relative? Yes, absolutely (no pun intended haha), great to be aware of that. But focusing too much on your relative rank eats away from the edge that got you to wherever you are and pushes you towards groupthink. Once you start the measuring contest, you’ve already lost. I think one of the Intel founders said something along the lines of “every new business sows the seeds for its own upheaval”. Yeah that’s true, but only once you start caring about the scoreboard.
- wiz21c 6y ago
  Had to look for it :-) https://en.wikipedia.org/wiki/Zero-sum_thinking https://en.wikipedia.org/wiki/Zero-sum_thinking
  - quietbritishjim 6y ago
    Zero-sum game [1] is the root term. An example is playing poker or similar (without any outside sponsorship or the like) - no matter how well we all play, there's no way for our combined wealth to be greater (or lower) at the end than it was at the beginning. Zero-sum thinking or mind set or whatever is the assumption that a situation is a zero-sum game, which may or may not be true. [1] https://en.wikipedia.org/wiki/Zero-sum_game https://en.wikipedia.org/wiki/Zero-sum_game
- JackFr 6y ago
  Though Karl Marx said it first. https://www.marxists.org/archive/marx/works/1847/communist-league/1850-ad1.htm https://www.marxists.org/archive/marx/works/1847/communist-l...
rdlecler1 6y ago
This may be true in public markets, but I’m not sure it extends to venture capital where not everyone can get access to the same opportunity. A good VC firm will not only see the best opportunities but may also pay far less in a competitive bidding environment. That’s where edge comes from.

"The race is not always to the swift, nor the battle to the strong, but that is the way to bet" —Hugh Keough

thaumasiotes 6y ago
Different context. If you're being offered the same odds on every bet, bet on the likely winner.
MaxBarraclough 6y ago
But it's not. From the article: > you want to bet on the mispriced horse, not the horse most likely to win
- tsimionescu 6y ago
  If one horse is given 1:50 odds but should have been given 1:100, how many races would you have to bet on to make money on those odds?
  - mmmmmbop 6y ago
    Let's assume the odds are fair such that the odds of all horses sum up to 1. Betting on all other horses would give you 1:1.02 odds whereas they should have been 1:1.01. While there is no way to answer for sure how many races you would have to bet on to make money, we can look at the probabilities. There's a 95% likelihood that the horse will lose 5 races in a row. If you start with $100 and reinvest your winnings every time you'd earn a profit of $10 with 95% likelihood, meaning there's a positive expectation value. On the other hand, if the 1:50 odds were right, the probability of it losing 5 times in a row would be around 90%, leading to a neutral expectation value.
  - MCneill27 6y ago
    Except investing isn't like a horse race. Each horse has a different finish line, and those finish lines are in flux during the race. Crucially, you can change your bet in the middle of the race.
chriswarbo 6y ago
I think that misses the point of this article. More appropriate might be: "The race is often to the swift, and the battle to the strong, but the way to bet is on those with miscalibrated odds." If the odds are well calibrated, the expected return is zero; we might as well not bet. The same goes for speculating on well-priced assets. If we have reason to believe that the odds/prices are miscalibrated, we can expect a positive return by going long/short (depending on which direction they're off).
- thaumasiotes 6y ago
  Well, the original quote is more about making plans. Georgia is at war with Russia: who will win? You can -- and people very much do -- try to set up a situation with a massive payoff for you in the unlikely event that Georgia wins. But the maxim is there to remind you that Georgia isn't going to win. Interacting with a bookie is a whole different context than interacting with reality.
  - Robin_Message 6y ago
    > Interacting with a bookie is a whole different context than interacting with reality. I think the point of the article was that interacting with the stock market (and potentially other areas of many businesses) is more like interacting with a bookie than interacting with reality.
    - thaumasiotes 6y ago
      Yes; I'm just saying I don't think the article's point detracts from the maxim.
  - chriswarbo 6y ago
    I'd still say it's not the likelihood or the payoff which matters, it's the expected return. If the payoff is massive enough to overpower how unlikely it is for Georgia to win, then it's worth setting up. It's also worth setting up situations which pay off if Russia wins, and the higher likelihood of that outcome should make us accept situations with lower payoffs in that case. I can think of a few reasons not to follow this strategy: - If our uncertainty is too high, we might want to avoid the risk; e.g. even if Georgia wins, we might not get anything out of it. - If the commitment is too high, e.g. a Martingale. - If setting up one outcome puts another at risk; e.g. if we fund Georgia's war effort, such that Russia would retaliate if they win; or the other way around; or both!
jorangreef 6y ago
That's a nice riff on the original: "Again I saw that under the sun the race is not to the swift, nor the battle to the strong, nor bread to the wise, nor riches to the intelligent, nor favor to those with knowledge, but time and chance happen to them all." —Ecclesiastes 9:11 To understand where Ecclesiastes is coming from: In the wisdom literature, books like Proverbs will typically state the common case and it's Ecclesiastes that will state the exception. This keeps the wisdom literature balanced as a set of principles, not rules. The Hugh Keough quote is a great summary then of the main point, which I won't restate.

A nice post! The initial part of the article with the efficient markets hypothesis (satellite data and app download data are table stakes for investing) rings a bit hollow for me in a world where bankrupt Hertz is seeing its share price go up though...

QuesnayJr 6y ago
If you sincerely think that Hertz is overvalued, why don't you short it? It seems like an easy money-making opportunity, if so.
- haakonhr 6y ago
  Not if they don't believe that the markets are efficient. It doesn't matter if you are, in some sense, "right" if the market disagrees. Wirecard is a prime example of this: a lot of short-sellers that, in the end, were right about the fact that it seems to have been a house of cards lost a lot of money.
- fancyfredbot 6y ago
  Because the market can stay irrational longer than I can stay solvent
- eru 6y ago
  Unfortunately, it's not that easy. The regulatory environment is not kind to short sellers. Matt Levine's Money Stuff often has examples of how shorting can go wrong. Recently there was a company that was accused of fraud. An obvious target for shorting. But: once the fraud properly came to light, the authorities promptly halted trading in the company's stock. After trading was halted, the shortsellers could not cover their shorts. And of course, in order to shortsell, you always need someone willing to lend you the stock in the first place. In the case of Hertz, https://fintel.io/ss/us/htz https://fintel.io/ss/us/htz does suggest that plenty of shortselling is going on. But https://finance.yahoo.com/news/why-bankrupt-hertz-short-squeeze-173507444.html https://finance.yahoo.com/news/why-bankrupt-hertz-short-sque... suggests that finding Hertz stock to borrow became harder over time.
- 6y ago

AznHisoka 6y ago

I disagree somewhat with #1. Long Amazon, short JCPenney is an example of an obvious trade the past 5 years. Or even the past 2 years. Same with long Apple in 2012 when iPhones were ubiquitous. And you would have obliterated the index with those trades. Sometimes you don’t need an edge. sometimes the most obvious idea is the most profitable. And my theory why is because if it’s obvious, it’s because everyone else is in love with the idea as well and putting money into it. And in the financial world, people don’t just put money into it once. They add on to it month after month after month. So you don’t necessarily need to be early to profit well. Let the big trend appear, then invest big into it once it becomes clear as day. Because huge trends last longer than you think.

dannyw 6y ago
Specifically, there is a style of investing called “trend following” or “momentum” where you literally just buy things that are going up, and sell things that are going down. This works wonders and has been a constant source of factor alpha.
- eru 6y ago
  They have been a reasonable source of alpha some of the time. But not a constant source all the time: trend following can badly go wrong. And, of course, because so many people do trend following these days, trend following itself will work less well in future.
- r_singh 6y ago
  Identifying these "things" (assuming you're talking about options/futures) and getting the timing right is the hard part.
swyx 6y ago
as someone who was in a hedge fund shorting JCPenney in 2015, let me assure you that it wasn't "obvious". jcp was one of the most shorted companies in the entire world, its valuation was already low, and if it saw any real turnaround (as was hoped when they hired their ceo from Apple) all the shorts would have been obliterated. careful when you armchair quarterback with literal 2020 hindsight.

hamilyon2 6y ago

I don't know, this > It's how the stock performs relative to expectations that determines whether you make above average returns or not. is like, investment 101 knowledge. Anyone who ever came near managing a portfolio understands that.

taneq 6y ago

Well yeah, you want to bet on undervalued horses, not just fast ones. Likewise with stocks, it's hard to argue that Tesla isn't doing well, but you'd be bonkers to buy their stock right now.

bjarneh 6y ago
> but you'd be bonkers to buy their stock right now. You're probably correct; but didn't people say that when they went above $200 as well?
- huffmsa 6y ago
  Yeah I've been hearing that basically since the IPO. Has yet to payoff.
  - OJFord 6y ago
    Too much FOMO and not enough 'I'd be bonkers to' - for as long as that's the case it pays to follow the FOMO! (Not investment advice I'm willing to follow myself! But a comment elsewhere in this submission, and a recent Levine column, have discussed that.. yeah, basically following the trend works... I suppose it shouldn't be that surprising, add more signals and act more quickly and you've reinvented a successful industry/form of professional trading.)
- eru 6y ago
  Yes. In general, you should only invest in individual stocks, if you know something that the market doesn't know. Otherwise, just buy the most boring and low cost index fund you can find.
- virgilp 6y ago
  OTOH, it's a generally a bad idea to invest in a company when the primary owner & CEO looks at the stock price and tweets "LOL". I feel it'd be a rational decision to short TSLA now except that "markets can stay irrational longer than you can stay solvent". And also I like Tesla, don't want to short it :)
- 6y ago

jakozaur 6y ago

It's contrarian article: 1. In many tech area: networks effects and zero marginal costs creates winner(s) take all. In that sense it make sense to follow the winners as previously investors underestimated how big winner could be (e.g. Amazon, Google, Facebook, Apple). 2. Everywhere else: betting on underdogs that are mispriced is much better strategy in long-run. See Warren Buffet got huge returns by looking at fundamentals, but his strategy would not work well in tech.

fancyfredbot 6y ago
I think the point was not that you should invest in Yahoo (for example), it was that you should only invest in Google if it is underpriced.
- ptero 6y ago
  In many cases in tech knowing something is underpriced is only possible after underpricing is gone.
baxtr 6y ago
Exactly. Because if not, why isn't bing on par with google by now?
- Retric 6y ago
  Bing does seem to be on a slow upward trend: https://www.statista.com/statistics/216573/worldwide-market-share-of-search-engines/ https://www.statista.com/statistics/216573/worldwide-market-... It’s still only 6% of global search vs 86% for google.
  - kohtatsu 6y ago
    I wonder how much of that is from dark patterns in Edge.
    - stormdennis 6y ago

zuhayeer 6y ago

Looking at everything as relative to each other is a slippery slope to zero sum mindset. Are things relative? Yes, absolutely (no pun intended haha), great to be aware of that. But focusing too much on your relative rank eats away from the edge that got you to wherever you are and pushes you towards groupthink. Once you start the measuring contest, you’ve already lost. I think one of the Intel founders said something along the lines of “every new business sows the seeds for its own upheaval”. Yeah that’s true, but only once you start caring about the scoreboard.

wiz21c 6y ago
Had to look for it :-) https://en.wikipedia.org/wiki/Zero-sum_thinking https://en.wikipedia.org/wiki/Zero-sum_thinking
- quietbritishjim 6y ago
  Zero-sum game [1] is the root term. An example is playing poker or similar (without any outside sponsorship or the like) - no matter how well we all play, there's no way for our combined wealth to be greater (or lower) at the end than it was at the beginning. Zero-sum thinking or mind set or whatever is the assumption that a situation is a zero-sum game, which may or may not be true. [1] https://en.wikipedia.org/wiki/Zero-sum_game https://en.wikipedia.org/wiki/Zero-sum_game
JackFr 6y ago
Though Karl Marx said it first. https://www.marxists.org/archive/marx/works/1847/communist-league/1850-ad1.htm https://www.marxists.org/archive/marx/works/1847/communist-l...

rdlecler1 6y ago

This may be true in public markets, but I’m not sure it extends to venture capital where not everyone can get access to the same opportunity. A good VC firm will not only see the best opportunities but may also pay far less in a competitive bidding environment. That’s where edge comes from.