"Life is like a multiple-choice question; sometimes, the choices confuse you, not the problem itself." ~ Anonymous
Have you ever attempt a test in a multiple-choice question format? Do you notice that those who finished the test early tend to be the one that ace the test? You might be one of them at some point in your life. When you are competent in the subject tested, the answer jump at you. You will find the test effortless. And yet, within the same test itself, there are probably others who took a bit longer and still come out failing it. Same test, but the knowledge level differ quite a bit. There are some investment skills here that we can learn from the MCQ test. The most important skill is that of working the odds and thereby making better choices.
Let's say you attempt a question with four choices, and only one of them is correct. The odds are one in four that you will choose the right answer. That is assuming that you know nothing about the subject.
But once you know something, the odds change substantially. Suppose you know that there is one obvious wrong choice, but you are not sure about the other three. Then your odds improve from one in four to one in three. And if you know even more, then the odds could improve from one in three to one in two to even a hundred per cent certainty. For a data scientist, they will say that it all depends on what data is in your head.
It all begins with better awareness.
The same skill set is at play when you are placing bets in a casino or betting a soccer game. To win the game, you have to put the odds in your favour.
You have to understand the rules of the game well and to work out the odds. There is a certain language spoken in every game. Once you understand the language use, you can begin to figure out the odds. In most instances, some simple maths will get the job done.
For example, let's say you walk into the casino and sit down at the roulette table. The roulette wheel has 37 numbers: 1 to 36, which are arranged in an alternating pattern of red and black; and the green number zero, which is a special case.
What are the odds that you will win at the roulette table? From the look of it, you might say the odds are 50% especially after you watch Ashley Revell's video on youtube. But you also know from hearsay that the casino always wins. So the wheels odd must be biases in the casino's favour. Without working out the odds, you would not be able to tell. Let's work it out and see how the numbers tell us about making better choices.
Let's say you bet on red. The odds that the ball lands on red and you double your money is 18/37. The odds that you will lose the entire sum is 19/37. The thing is that, when you are sitting there in the roulette table, you don't feel this way. You might even think that luck is on your side. Sometime, you might even have what is called a streak where you win multiple times in a roll. But for the casino, they know that if you stay long enough, your money will become theirs.
For those who are interested in the expected return, the number is minus 1/37 for the roulette game.
If you go one step further, you might even work out the variation around the expected return. In which case, the number would be :
𝜎^2 = 18/37*1.0547 + 19/37*0.9467
Does that look familiar to investing?
In the investment marketplace, it is the same thing. We are presented with different options every day that are not clear cut. Sometimes, one option is better than the other. But how will you know?
The avid traders don't bet on trades that they do not have a good odds on. They know that if the odds are not in their favour, sooner or later they will lose their entire principal sum. It is just like a roulette's game.
But once you know the odds, you can choose not to play the roulette's game. You can select a game that you have better odds on.
It is like a multiple-choice question. Know the odds, and you will make better choices.
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