Heuristics and Cognitive Bias: the Reason Most Fail at Betfair Trading

When I went for an interview at an investment bank for a place on its trading programme I was subjected to a two day assessment centre where I went through a number of psychological and psychometric tests. I obviously did ok as I was later offered a job and a place on the programme.

I did not realise it at the time but the bank was screening for individuals whose mental processes involved the fewest mental shortcuts “heuristics” and cognitive bias.

I suspect many readers will switch off at this point (if they’ve got this far!) thinking “what a load of rubbish I just want to make a few quid on Betfair!” If they are one of the lucky few who are not affected by heuristics or cognitive bias then good luck to them. However the studies show that such people are in the minority to such an extent that 1.01 would offer value on them being affected.

If you have stuck with me…

Heuristics

Psychology splits the making of predictions into two parts: intuitive and quantitative. Intuitive predictions are made by a person running through possible outcomes, relying on personal knowledge, experience and common sense. Quantitative predictions on the other hand are made using only objective data and the data’s relationship to the outcome. With quantitative predictions there is little, if any, subjective (or “thinking”) component.

Why is this important? Numerous studies have shown that simple quantitative models outperform not only the average person but individuals that are supposedly experts in their fields. For example:

Lewis Goldberg showed that experienced clinical psychologists failed by some margin to beat a simple model in diagnosing patients.

Andrew martin and Kevin Quinn showed that a simple model was more successful in predicting the outcome of cases in the Supreme Court in the US than legal experts.

The studies conclude that the models beat humans because they reliably and consistently apply the same criteria over and over. It is this complete reliability in the application of the models that generates the better results. Models, after all, are never influenced by emotions. Humans, on the other hand, are quite the opposite. Not only are we emotional creatures are brains have evolved to be used to a life in the wild where instant decisions could mean the difference between living and dieing. Evolution resulted in us developing mental shortcuts – heuristics – that enable us to identify a danger and react before we are conscious of what that danger is. But take as an example the situation when you jump thinking that you have seen a spider, snake or whatever but shortly afterwards notice that the spider is a piece of fluff, the snake is a stick, etc. Here you have been the victim of the heuristic to avoid spider-like or snake-like objects.

Heuristics are clearly useful for survival but lead to cognitive bias that make it difficult for us to make logical decisions. These include:

Overconfidence – regarding our own judgement as better than it is.

Self-attribution bias – ascribing successes to ourselves but blaming others for failures.

Hindsight bias – believing after an event occurs that we had predicted it in advance.

Availability bias – placing more weight on information that is recent or easily brought to mind.

So how do you overcome this hardwiring that mother nature has imposed on aspiring sports traders? More on that in another post…