Flipping Coins

Don’t worry MMPI has not taken to using street slang. This week we want to talk about the art of flipping coins and to demonstrate some nuances that might be akin to stock-market investing.

A thought experiment was conducted at http://coinflipbet.herkuapp.com/ The organisers gifted $25 to participants and promised to pay out real winnings up to $250 – there were very few winners! The purpose of the experiment was not to test for gambling instincts but to learn about the various behaviours and disciplines adopted by participants. Erratic behaviour such as wildly increasing and decreasing the bets; or randomly switching from heads to tails based on the last few coin tosses was the most obvious conduct recorded. There were zero winners following these strategies.

Most of the winners collected less than $25 having bet consistently small amounts on selections of heads and tails – once again influenced by previous coin tosses. There were a small number of winners who bet heavily on the final coin toss and got lucky. But those that scored higher than $250, including MMPI, (yeah right! – Ed) were consistent in their approach. They first and foremost recognised that a steady strategy was all important and, therefore, they displayed faith in the rules of the game and patience in the face of a losing streak.

Likening this coin-flip experiment to real-life investing is fraught with danger but some observations are profoundly prescient. In the experiment there was an inbuilt bias towards heads of 60:40. There is also an inherent bias in stock-market performances – shares advance over time because companies grow and expand.

Sticking to a long-term and consistent investment strategy is a wise approach. It requires a belief in the discipline when stock-markets crash, as they do from time to time; and such consistency prevents investors from making rash decisions like spending large amounts arbitrarily, sometimes successfully and other times not!

There is a saying in investing folklore that creates more arguments than it resolves; “Time not Timing.” It contends, correctly in our view, that the term of investment is more important than the precise timing of the investment. For sure, doubters will argue that timing is everything but it is very difficult to get timing right on all occasions. A consistent approach is best in the long run.

One other finding from the experiment that is intriguing is the realisation that proportionality matters significantly. Say your first bet is $5, it’s important to recognise that this represents 20% of your available funds. When you have steadily bet $5 and raised the fund to, say, $100 – your bet has fallen to 5% of your fund. In other words, if 20% works for you at the start and your fortunes improve; then 20% should continue to work for you over time.

You can no longer take part in the actual experiment but if you have a few minutes to spare log on and prove to yourself the value of patient consistency and the fallacy of erratic randomness.