A coin Flip game
Conclusions and insights.
Please click on the title above to read or Play the Coin Flip game we shared yesterday.
Some fascinating insights came out of playing such a simple money management game.
BETTING ON TAILS.
There were some of us who bet on TAILS.
Why on EARTH would you do that!!. The rules clearly state that the coin is skewed and the odds of it coming HEADS is 60%. As a professional better, it was our job to bet HEADS every freaking time and yet, curiosity got better of us.
REMEMBER, there were no external stimuli in this simulation. In real life, you will have all shape and size jokers from business channels spurring you on to buy or sell stocks. Your curiosity has more than fair chance of getting better of you there. This may sound an exaggeration, but for a lot of retail traders out there, majority of their investment decisions are a trigger response to any of many stimuli out there!!!
BETTING too BIG
To end with $58 after winning $23 must have meant that this person has thrown a kitchen sink at this bet. He basically went ALL IN.
When your bet size is too high, its not if but when you will go bankrupt.
KELLY is TOO WILD.
Another thing you notice is that according to Kelly formula, one needs to bet 20% of the bankroll on each bet.
As I have shared earlier (elsewhere), Kelly is OPTIMIZED bet sizing. It doesn’t care about downside. So while it shows you crazy returns, it comes with even crazier drawdowns, see the wild lines below. This 20% bet chart would make Cathie Woods look like Mother Teressa.
Half KELLY is the sweet spot.
Ed Seykota in his seminal paper Determining Optimal Risk talked in detail about the Sweet spot that every system has. Below which it is under optimized and above which it starts losing money!!!
In our example, that amount seems to be half kelly (10%), infact best way to trade is to start even more conservative and do half kelly or kelly betting with the cushion of the accumulated profits.
Further reading
If this topic interests you, I would highly recommend you the following 3 sources.
Non Ergodicity and its implications by Prof Sanjay Bakshi
Position Sizing Webinar by Manish Dhawan
SBF was reckless from the start by Matt Levine
