You may not have realised, but we all have a tendency to value money differently in certain situations. Let me begin with a story, this one does the rounds in Las Vegas, judging by the amounts of money involved I do have my doubts about the truth in it, but it does illustrate perfectly one of a few psychological problems we have with money, and it's in a gambling context, even better! It's called, "the legend of the man in the green bathrobe".
"By the third day of their honeymoon in Las Vegas the newlyweds had lost their $1,000 gambling allowance. That night the groom noticed a glowing object on the dresser. Upon closer inspection he realised it was a $5 chip they had saved as a souvenir. The number 17 was flashing on the chip’s face. Taking this as an omen, he put on his green bathrobe and rushed down to the roulette table where, not surprisingly, he bet on number 17. He let his winnings ride and eventually he was worth $7.5 million. Unfortunately the floor manager intervened, claiming the casino didn’t have the money to pay should 17 win again. Not to be deterred, the groom caught a taxi to another casino where he bet all on 17 again, when it hit it was worth $262 million. Needless to say, with such luck he bet again, only to lose it all when the ball fell on 18. Broke and dejected, the groom walked the several miles back to his hotel. ‘Where were you?’ asked his wife. ‘Playing roulette!’ he replied. ‘How did you do?’ ‘Not bad, I lost $5.’ "
This had me laughing when I read it, but then I realised this is exactly the sort of mind set that affects some people, particularly gamblers. Admitedly, no one in their right mind is going to bet $7.5m on 17, let alone $262m! But the point about how he felt he only lost $5 is perfectly apt.
Another illustrative scenario is one where you have two items to buy, one is worth £50, and the other is worth £2000. In both cases, you arrive at a store selling these items to find that they are priced at £75 and £2025, but there are locations 5 minutes drive away which have them at the correct price. Almost everyone would decide to drive 5 minutes to save £25 on the £50 item, a much smaller percentage would do so for the £2000 item. Yet both £25 savings are equated to a 5 minute drive.
Finally one more scene for you, imagine there is an item you've wanted for a very long time, but it's not quite been easily affordable. Let's say this item is £500, and you've seen a deal for one priced at £470. Later on, you are investing in a very big lifestyle purchase, perhaps a car or some expensive equipment, the cost for this is £15000. The dealer selling you this, then takes the opportunity to offer you the item you really wanted earlier as an add-on for an extra £600. Suddenly this doesn't seem like such an expense, you are already spending £15k, you take the opportunity to get something you've wanted for ages whist spending the money, "what's an extra £600 on the top of £15k?".
Each scenario slightly different in psychology, they all have particularly wide ranging importance when looking at how we manage and save our money generally, but they are also brilliantly applicable to gambling and trading. Lets deal with the last one, first.
The first thing that struck me was how easy it is to view money as cheaper the more you spend, and how often I have been affected by it. I have to wonder how often others are struck down by this mentality too. Clearly when we think of this scenario in a gambling context, we are talking about adding to losses, or averaging down a losing position by making the bet even bigger, because we see it as cheap.
It became obvious to me that this is one of the reasons a lot of people go bust or never get anywhere. In fact, the three scenarios together form a big part of whether you will win, win for a while then give it back, or go bust.
If you are losing whilst trading, it's very easy at times to convince yourself to add to your position - if you are already losing £10k, what's another £1000 ? The answer of course is £1000! And that's a lot of money. It's also money that you will potentially have to work many hours to make back. The more hours you work making back 'throw away money', the more pressure it places on you. It defeats many people in the long run. Before you know it, you are simply treading water / money, and that's if you are lucky enough to be fairly strong willed.
Don't add to losing positions. Just because you are losing money, it doesn't make losing more money any cheaper, all money is equal and it's all work. Cut your losing positions, save yourself hours more work, heartache and money.
Lets go back to the man in the green bathrobe. They call this the mentality of playing with 'house money'. Mentally you consider it the casino's money rather than your own, because you 'won' it rather than earned it. In other words, it's not real money. ...It's always real money.
This is a classic example of how people who do well for a while, give it all back many times faster than they made it. All the while justifying their actions by telling themselves that they were 'just playing with the profits', 'it wasn't really my money', 'I started with £100, I still haven't lost that, so I haven't lost anything'... what about the £5,000 you just lost then?
You put this in writing and it looks crazy, but this happens all the time in gambling and trading circles. The forums are littered with stories of 'giving it all back' etc.
Finally, lets look at our second scenario. The one where the amount of effort is worth the same amount of money, but is disguised by the amounts being spent. You have to think and act efficiently to make gambling / trading pay. That tick you gave up in order to get matched, that cost you. That time you crossed the spread, took someone else's offer, that can cost you on many levels in the long run.
I've recently done a lot of work on analysing my activities for the last 15 months. Betfair were kind enough to send me through a detailed spreadsheet with all the matches that I had traded on in that time, my profits and losses and traded volumes etc. The sheer scale of what I had done was quite a surprise, even to me. 1066 matches traded and matched volumes of many £10m's, seeing figures like these made me realise many things,
- My edge during that time was a tiny %.
- This was the sum of all my actions, good and bad, during many hours of work.
- Because of the sums traded, a very small improvement in my actions could result in a massive leap in the amount I could win.
- The efficiency of my actions was incredibly important over long periods of time.
- Every £ is equal ! I needed to value all money.
- All the times where there had been 'throw away money', I had spent days and weeks making it back, had I not thrown it away, the profit column might look very different.
How do you avoid these psychological traps? Three ideas for three scenes.
- Avoid the 'house money' mentality, by keeping physical/electronic records of your activity. Avoid accounting for things in your head, if it's in your head alone it is very easy to write off as not being real. This will also help you analyse your actions over longer periods of time.
- Withdraw your winnings. Don't keep them in your online accounts, whilst they are there it is much easier to see them as just that - "winnings". It becomes tempting to mentally reassign this money as just profits and not really yours. Take the money back to a designated amount every so often. I know people that do this every day, it's a good idea.
- Cut losing trades, don't add to them. Set your limits on size, don't go over them. Evaluate each opportunity and trade them as efficiently as you can - get as many ticks as you can, ask for prices rather than take them. Every action you make over the course of a year makes a difference to your bottom line. Value every £ that you play with as real.