Jumping on Board the Winners

In a previous article we discussed regression to the mean as a way of looking at gambling in the long term. Here we will use the theory to talk about a significant and interesting point of gambling within a population. A better view is provided with an example from the stock market industry.

Let us suppose that you we have just read a book about some of the most successful stock investors in the world. In fact, the book was written by the investor who made the most money trading stocks last year. In the book, he tells all the secrets, the no-no's, and tips to become as successful as he was.

No doubt he made a lot of money by trading shares, and is making even more now that people are reading his book. However, we have to ask ourselves, how much of it is due to chance and how much is because he actually is a top analyst?

To find an answer we look at an example. Suppose there are one million traders in the stock market, and suppose that each were trading blindly. In other words, they were buying and selling stocks basically at random! Now naturally, there would be some winners and some losers. Over the course of the year, if the stock market has increased, more than likely there will be more winners than losers. However, there will always be one person at the top, the person who has gained the most.

Now obviously, in this case, we know that he has gained the most by being lucky as along with everyone else, he was trading blindly. The punter decides to write a book detailing his apparent genius ability of selecting value stocks.

The same occurs with gambling. There are countless 'systems' and 'tipsters' who have very good records. Assume for our hypothetical that there are a thousand systems commercially available and that all bet blindly. As the odds are against you with gambling (although the real professionals turn it in their favour), let's say 60% of these tipsters and systems lose and the other 40% win.

Now, no one wants to follow a losing tipster do they? Therefore, these tipsters stop their services, perhaps change names, new web pages or something of the sort. We then find that there are 40% of the thousand tipsters, or 400 tipsters who are making money, but we know that it's due to pure luck! All of a sudden everyone starts purchasing systems or following tips of successful tipsters, who are only there because of luck, and according to the theory of regression to the mean, will most likely lose in the long term. Note that I aren't suggesting that simply because the tipsters won for a period that that share of good results must be evened out by poor results. Rather that long term they are losing players. Their results will tend to regress back towards the mean or back to a point that they expect to be over time.

Notice that previous sentence ended with the words 'long term'. It is the 'long term' with which we are really concerned. How do we know if tipsters, systems, or stock brokers are successful? We decide based on the long term.

The stockbroker, who won heaps of money last year, may have done really well that year, but how did he perform the previous years? If he was still gaining in previous years, we could say that he probably is good at what he was doing. If he lost or only just started trading, then it is possibly due to chance that he is at the top.

If we are looking to follow a tipster, a system or even a friend who tells us he is doing well at gambling, then we do not just find out how well he has done in the last month, last six months or last year but find out how well he has been doing in the last three to four years. Luck doesn't follow someone for three to four years and if someone is still making profits over this time, consistently each year, then it is obvious that they know what they are talking about.

Similarly, with your gambling, if you're doing really well over the past three to six months, don't put all your eggs in the one basket. Expect future loses as well as wins, and only when you have a long term successful betting history behind you, can you then increase the ante a little because you know that it was not all luck that put you in the position that you now find yourself. It requires two or more years of successful betting history before one can tell if luck has, or has not, played a part.

Of course, there also are mathematical methods which may be used to calculate the chance that their results may be due to luck, or they have the ability to show a long-term edge. These are discussed in other articles list in our article bank.

To discuss this article on the Punting Ace forums, click here.

Matt Elliott

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