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Posted on June 21, 2013 @ 07:05:00 PM by Paul Meagher
In my last blog, I suggested that to be a better business investor, you should focus on making your investing process more skillful
rather than focusing on short term results because business investments are subject to significant "luck" or "chance" factors that are not
fully under an investor's control. If an investor focuses on improving their investment process rather than focusing exclusively on short-term results, then over the long haul it might produce better returns and result in less short-term anguish over outcomes.
So what does a skillful gambling process consist of, and, by extension, what might a skillful investing process look like?
Non-Self-Weighting Processes
Some advice from gambling theory is that profitable gambling processes are non-self-weighting.
This terminology is due to Mason Malmuth from his book Gambling Theory and Other Topics, 2004, p. 16.
Quickly recapping, self-weighting gambling strategies are those in which many plays are made for similiar-sized bets, while successful non-self-weighting strategies attempt to identiy where the gamble has the best of it and then to make the most of it. As already noted, only non-self-weighting strategies, where appropriately applicable, are profitable for the gambler.
To properly grasp the concept of "self-weighting" I think it helps to formalize the concept a bit.
A perfectly "self-weighting" (SW) betting process is one that consists of N betting events wherein you bet the same amount on each bet for all N betting events (e.g., each hand of poker). The individual bet would be equal to the mean bet for all betting events (e.g., bet $20) producing 0 dispersion among betting events. Someone who is reluctant to bet more on hands with good odds tends towards the ideal of a "self-weighting" betting process. They are not likely to be successful gamblers.
A "non-self-weighting" betting process (NSW) is one in which there is significant variation in bets accross events and significant non-participation in some betting events. When a skillful gambler earns a profit after a round of poker, this could be indicative of playing the betting odds successfully, not participating in some hands, and not recklessly going "all in" on any one bet.
The successful gambler minimizes risk by playing the odds successfully. This consists of dropping out of many hands and betting more in those hands which have favorable odds for winning. Over the long haul, this can produce profits for a gambler provided they know how to also manage their bankroll to stay in the game (e.g., don't go "all in" and lose your bankroll). On each bet/investment you are managing "money" in the short term, but your "bankroll" in the long term. Bankroll management is of more concern to the successful gambler than money management.
I am not suggesting that you treat business investing as equivalent to poker betting. What I am suggesting is that the theory of gambling has some concepts that might be useful for thinking about the fundamental nature of successful business investing, namely, that is a non-self-weighted process.
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