Books For Decision Makers: Volume 4 AlphaBrain
How a Group of Iconoclasts Are Using Cognitive Science to Advance the Business of Alpha Generation
Have you ever had a moment where you don't remember doing something, but the proof that you really did it is right in front of you? One explanation for this situation is provided by Kahneman with his "System 1 and System 2" proposition. He calls System 1 that part of our brain that plans and decides which actions to take. We are conscious of this process. Richard Thaler, 2017 Nobel Prize winner in economics, calls this the "planner". On the other hand, System 2 is the "doer". This part consists of the decisions we make that we are not even aware of. Even if you don't believe it, most people let System 2 make most of their decisions. Right now you’re probably saying to yourself not me, or do I?
In Stephen Duneier’s book: "AlphaBrain: How a Group o Iconoclasts Are Using Cognitive Science to Advance the Business of Alpha Generation," a study is placed on how we actually make decisions, and what are decisions; and we will be able to see this in a more cognitive and scientific way.
Decisions, no matter who you are, what you do or where you’re from, we all make them. Our lives are a never ending string of the decisions we make, which shapes and determines the way we live.
Nevertheless, people usually justify a bad outcome with bad luck or an unfortunate occurrence; but never do the same for a good outcomes. People usually justify good outcomes with talent or a sound decision making process. But what is the "decision process"? Maybe an even more important question, what is our role in our self-decision making process? Duneier brings to the table this question and more in his book, showing us a more scientific justification of how, with marginal improvements in our decision making process, we can have a huge impact on the results. More on this in a moment.
First, we have to answer this question ourselves: Are we bystanders or active participants in the decisions we make? Now, this question may seem a little unusual or even offensive, but the truth is that, in the thousands of decisions we make per day, we let the heuristics, the mental shortcuts make the decisions more often than we should. We are not saying to do a deep analysis of every decision that we face during the day, that would be impossible for any human. We need heuristics and mental shortcuts to function normally on a daily basis, it has many benefits. When we wake up every morning, we have made some decisions at that moment, we have decided if we are going to snooze the alarm or if we are going to get up immediately, are we going to take a hot shower, a cold bath, etc. And those decisions are made systematically every day, the path we will take, the bus we are going to ride and even if we are going to acknowledge someone or something when we arrive to the determined destination.
In order to achieve our dreams or almost any goal that we set ourselves up for, the first step is to wake up from this passive position in our decision making process. Duneier compares this moment, when we stop letting heuristics, or mental shortcuts, make most of the decisions that we encounter. That moment in Matrix when Neo takes the red pill and decides to see the world as it truly is. We have to wake up and start stimulating the skill of making decisions, because what stands between us and achieving our most ambitious dreams has far less to do with possessing some special skill or talent and far more to do with how we approach problems and make decisions to solve them.
Novak Djokovic is the perfect example of how marginal improvement can make a really big difference. When Djokovic first became a pro player, he was ranked 600+ in the world. A couple years later, he had scaled to the third position. Finally, in 2011, he became the best tennis player in the world and one of the all-time greats in tennis history. What took him from being ranked 600+ to the very first position in the ranking? A special, unique talent or skill? Probably not.
Looking at the stats of Djokovic's career, we can see the evolution of his percentage of points won throughout three different stages. The really interesting statistic is that, by improving only 6 percentage points in his percentage of points won, it took him from #600+ position to the #1 position (see table Table1).
Table 1: Novak Djokovic’s career stats. Source: Duneier, S. (2019).
How is that he went from winning $300,000 to $14 Million by improving by only 6% of his points won? The answer is that marginal improvements can have a dramatically large effect on our lives in the long term. For some people, settling down and working hard might be easy, but that is not the case for most people. In the case of Novak Djokovic, he didn't control his rank, annual prize money, nor matches won. These variables were too big for him to handle that easily; so he "just" settled for smaller, marginal tasks that, in the long term, would make a difference. He focused on what he could control, consistently finding a way to win more points. With more points, came more games, more matches, more wins and more success. This is one of the most important and general take-home advice from Duneier's book: disassemble a big/complex task in small, marginal parts and you’ll be able to more easily handle tasks. For example, if you can't concentrate for more than 15 minutes, then organize yourself and set all your obligations to structured, 15-minute little tasks.
However, Novak Djokovic's success was not a consequence only of solely little, marginal improvements in his percentage of points won. Another essential rule for success, very general but extremely hard to do: don't make mistakes.
For this example, Duneier used Bill Belichick, the head coach of the New England Patriots in the NFL. Contrary to what some may think, the objective of football is not to score the maximum number of points possible in a match. It is simply to win, no matter if you win by 1 or 50, just win baby. This is a question you have to ask yourself when you want to improve on something and achieve your most ambitious goals: what exactly are you trying to achieve? Because sometimes we set a path to something that we don't necessarily need to achieve in order to accomplish our real goal at hand. Novak Djokovic could have tried to achieve a 100% success rate on his serve, but probably that would have been nearly impossible to achieve, and in trying he probably wouldn’t have reached his true goal of being the number one player in the world. He started small, win more points. The same approach can be applied to our day-to-day problems: What will it take to have better grades? Have high returns in your portfolio? Get that new job? These questions could also be stated as a more general question: What will it take you to get better results in any activity?
And the answer is, study the approach that you are using, and find out where it is that are you failing. Then, start making marginal adjustments with simpler tasks.
Now, back to the case of Belichick. He has been the most successful head coach in NFL history. As of this publication he has won a record 6 Super Bowls as head coach (2 more as an assistant), more than 68% percent of his total games, more than 74% with the Patriots, in which he has never had a losing season in 20 years, and more than 80% of his regular season home games. Contrary to what you may think, the secret to his success is simpler than we want to admit. Yes Belichick has Tom Brady, one of the greatest quarterbacks ever and his interviews are boring and often snide, but this by design. He never lets something interfere with the end goal. As he tactfully puts it, “Before you can win a game, you first have to not lose it” or “We didn't prepare for them. We prepared ourselves. If all 11 players on offense, 11 on defense, and 11 on special teams simply do their job, we have a good chance to win.”. The more general the better, you may think; but the truth is that Belichick's tactic consists of one simple thing: Don't make mistakes. If we think of it this way, we can see that most failures in life are a direct consequence of a mistake.
Djokovic’s approach was to minimize his mistakes, what mistakes? Points conceded and unforced errors. He trained to minimize points conceded by 6%, and this took him to being one of the best tennis players in history.
What was Belichick's approach? Simple, he makes his players minimize any mistakes they could make on the field and trained them to focus on each possession, each play, throughout the match. What was Belichick looking for with this tactic? If his players don't make any mistakes, it means they have the greatest chance of scoring points, or when on defense, minimizing the other team's chances. All of this is predicated on his team having the greatest possessions. They want to control the number of possessions, control the time of possession and maximize their opportunities. Make the most of the opportunities they have as a team and stop making mistakes. This is only 50% of the full picture though. The other 50% remains in the next principle, Capitalizing on other's mistakes.
Stop and think about what we have done until now. Stop leaving heuristics to control your decisions and make a deep analysis of your decisions that are rational and objective; analyze the way you approach your problems and determine where are you failing; set a new approach, based on marginal improvements in "simpler" tasks, in an effort to reach your greatest goal in the long-term; finally, don't make mistakes. Up until this point, we have been building a brand new path for achieving our goals. We have committed in our attempt to stop making mistakes and making decisions based on marginal improvements in order to achieve what we want. But if nobody makes mistakes, we are in a sum-zero game, where winning reduces to luck. If all teams in the NFL have the same players and capabilities, and they are all coached by Belichick, they would probably all end the regular season with the same results. Even if this is not a real scenario, we can see that the winnings of some people are the losses of others. This is what we have to take advantage of. Djokovic not only improved his technique to improve his percentage of points won, but he learned that if he wanted to do so, he had to capitalize his rivals' mistakes. He had to learn how to read the movement of his opponents and how to take advantage of their positioning. Even without having the greatest technique, he was able to exploit his opponent’s vulnerabilities and capitalize on individual points over the course of the match. This is why working toward improving your skills to the absolute maximum, is not only not enough, it’s probably a waste of resources that you could dedicate toward improving other abilities, that overall will increase your overall goal of achieving your big goal.
Many experiments demonstrate have been conducted that shows that more information doesn't necessarily take us, humans, to better outcomes.
We can’t just gather, organize and understand all of the possible data that we need in order to make a decision and be certain that it will lead to success. We are not machines, and even if we have a machine doing this for us, it is only making a prediction based on the information we have input into the system. It doesn't guarantee positive results. Many experiments have shown this same result for portfolio managers or stock traders. Having access to all of the data in the world won't make you better than others. Too much information will be noise in your decision making process. Your brain will not be able to handle it properly. If you are a tennis player, no matter your talent, or how many hours you practice your technique everyday, at the end of the day it’s your decisions that will make you. Equally a portfolio manager's decisions might be affected emotions, biases or noise that you don’t even realize are there.
Remember the context. Decisions you are aware of (System 1), and even those made without noticing (System 2) can be incorrect because of a cognitive bias, or systematic error in thinking.
Some of these biases are related to memory or way you remember an event may be biased for a number of reasons that in turn can lead to biased thinking, judgement and overall decision-making. For this reason, before you even start looking for your brand new, expensive investment services or high-end equipment of any kind, you have to minimize your cognitive bias. Learn to minimize your mistakes, identify the mistakes of vulnerabilities of others and capitalize on them.
These are some of the take-home acknowledgements from Duneier's book:
Stop making mental shortcuts for important/relevant decisions in your everyday decision making process, and make a deep analysis of this process.
Marginal improvement is the key: disassemble big goals into smaller, doable tasks.
Don't make mistakes: slightly fewer mistakes can make the difference. Rational decisions are what we should try to achieve.
Capitalize on other’s mistakes: this is where the most gain is.
Minimize cognitive bias and try to identify it in your daily decision making process.
Rational choices are not always the right choices, as they might be affected by luck, but they are your best choices in the long-term.
David Leonardo Gonzalez
Macrowise Content Collaborator
Septiembre 26th, 2019