Make your bet and toss the coin
About this challenge
What a simple "Head or Tails" can teach us about the market
This challenge replicates an experiment created by researchers Victor Haghani and Richard Dewey in which they invited 61 students of finance, economics, and young investment professionals to test.
In this test participants were asked to place bets on a "Head and Tails" system. Each of them had 30 minutes and started with a capital of $25. They could bet as much as they wanted (of that initial capital). For a bet of $5, for example, the person would lose $5 if wrong and $5 if correct. You could have all the capital you earned by participating in the experiment (up to a secret limit of $250).
But there is one caveat: the participants were informed that there was a 60% chance of Heads. That is: it is a "game" in which the odds are in favor of the trader.
If your are interested to try by yourself I suggest you to take the challenge above before you keep reading.
Results of the experiment
Despite their knowledge of mathematics and investments, most (79%) of the participants failed to reach the maximum payment limit stipulated by the researchers ($250) and more than 25% of the participants "blew the account"!
Many started in a disciplined way, but they got carried away by the emotions as the game progressed. Several began to suspect that the Head was not really more likely to turn up.
One of the authors concludes: "If a large proportion of qualitatively sophisticated and financially trained individuals have so much difficulty playing a simple game with a 'biased coin', what can we expect when it comes to the more sophisticated task of investing other people savings?"
You can check out the full article here here.
What does this challence can teaches to Traders
We can draw a parallel between this game and a trading account. In a way, it replicates a strategy that gives a 60% win rate and has a Reward / Risk ratio of 1:1 ("one-to-one").
Of course financial markets are quite more complex than this simple game. But there are still some similarities. Imagine that each round or turn is a trade . Soon you will realize how important it is to find the right value to risk on every "bet" (your stop loss) and how important it is to believe in your strategy.
What you may pay attention while playing
What is the maximum losing streak you have? Even when the odds are 60% in your favor, these sequences come.
What happens if you risk too much and end up losing two or three times in a row? What if you try to martingale?
How do you feel during the game? Are you happy with your results? Would you like to have better results?
Note: Since we will not give you the money if you win the game, we changed the starting amount from $25 to $250 in our version as this makes betting easier.
The mathematician John Kelly created in a 1956 a formula for calculating the proportion of a capital to risk in a sequence of bets that present a positive return expectancy. This formula became known as the The Kelly Criterion. In our case the suggested proportion is 20% of the balance.