lessons from markets on good decisions
In all facets of life, you are a market participant, and there are many markets. It is human nature that all market participants are selfish and wish to increase utility. Fortunately, they’re not all equally good at measuring it for themselves or for others. (more on this below)
You can make decisions in life according to the following function.
utility = value - cost
Neither of these can be truly measured.
There’s also what everyone else will do which will impact both.
There’s lots of asymmetry built into this so which is part of why it’s hard to measure.
- Cost is usually more visible than value — you feel what you give up, you often don’t notice what you gain until it’s gone
- Short term cost vs long term value is systematically misjudged — humans are notoriously bad at this, we discount the future too heavily
- Some of the highest value decisions are invisible — the catastrophe that didn’t happen because of a choice you made, you never “see” that return though it’s very much real.
For example, I love fruit juice (with no sugar added). When I buy juice, I’m trading against an informed professional who has determined the price that’s EV positive for them, which is why they’re selling.
Not all markets are efficient, and not all participants are informed, or maybe they are informed. There’s a million reasons to sell, but there’s only one reason to buy.
While it’s EV negative for me to buy the juice, the value (to me) is greater than the cost, so I engage in the transaction which has positive utility.
However, this is the first instance where genuine personal “alpha” lives — not in stocks or juice shopping, but in knowing your own utility function better than the market does. Finding transactions where your personal intrinsic value genuinely exceeds the total cost.
all value systems are not equal
A “value” is a property that you should seek to increase with every decision.
Important to remember, you get to decide what to value.
So what are the best things to value? You can pick them, but some things will probably stand out;
- Time (measured by lifespan)
- Health (healthspan, lifespan, emotional health)
- Knowledge (retrieval of and access to information)
- Optionality (liberty as a political concept should be thought of as a strict subset of optionality in this sense)
- Joy (this is the only variable where ALL of the squishiness must be allowed in, as you are the one who determines this, but note it is only 1/5th of the items in this list)
Presumably costs are the inverse (if you wanted to even attempt to account for this in a measurable way)
- direct costs (money spent)
- indirect costs (reputation, time, harm to relationships)
- opportunity cost (what else you could have done)
- time (A cost paid now is worse than the same cost paid later, can’t buy your way out of certain labor, taking a debt to borrow money from the future, etc. )
- optionality (getting married, having children reduce this)
Now if you COULD measure these decisions for yourself to determine value over time, you might do it this way;
What wins did your major decisions produce (slugging %)
You should be thinking about total utility generated divided by number of “major decisions” made.
Of course you want to use each “swing” carefully.
So you should ask how often did your big bets pay off in terms of what you gained, and by how much relative to the downside risked.
In other words rank each decision by weighted utility (value / cost).
Ideally, you only ever take swings with a positive EU (positive “EV utility”) to begin with, but that’s not always what creates SpaceX or Tesla either.
number of new decisions per year (swing count)
This is about surface area — how many important decisions are you in a position to execute on?
Someone who never moves cities, never changes jobs, never starts a new project has a very low number of “at bats”. Think about that optionality score — more options = more swings available.
More swings implies more chances to compound on good outcomes.
Unfortunately you can’t short a bad decision. The best you can do is take some risk you might have and transfer it (either with insurance or some asset like a prediction market) to hedge when you make a choice. You reduce your upside, but you hedge the downside. Buying insurance is the way most peopl do this without explicitly thinking in terms of risk.
sizing
The idea here I’d say, is whether your time/money/energy allocation is proportional to your conviction in those opportunities? The test is simple — write down your top 3 opportunities you see right now. Then look at where your time actually went last month. If they don’t match, you’re mis-sized.
note - time decay;
Your swing count naturally declines over a lifetime (fewer major decisions remain), so the value of a swing increases with age, which implies being more deliberate about sizing earlier when you’re young and swings feel abundant.
The illusion of goals
You might be wondering where things like goals and whatnot fit into this.
They don’t. If what you seek to maximize is utility, then goals are proxies, A.K.A. an illusion. If anything goals outside that are dangerous because they might cause you to optimize for the wrong thing.
They are usually constructive, but just be aware that they are metrics that are not what you ultimately want.
I’m a lawyer, so if I said for example, “I want to be a partner at a law firm”. That would probably require me to do things that are negative utility, and ultimately the title isn’t what I’d want. Perhaps someone who wants this really wants something like the respect of peers or self-worth. Better to be aware of that now.
ok David shut up and get to the markets
Markets are classically downstream lower level of abstraction of this principle, where you actually can measure value and cost discretely.
For market participants, I’ll add the distinction of ‘realized’ as you can’t calculate the cost or value until after you’ve exited any trade or position.
utility = realized value - realized cost
alpha - beating the “market”
- the goal is excess returns independent of what everyone else does (the market)
- Requires genuine edge — structural, informational, or analytical
- Zero sum by definition — your alpha comes from someone else’s mistake
- Requires constant renewal as edges get competed away
- Genuinely hard, most professionals fail at it
beta - wealth accumulation
- Goal is to grow wealth over time by participating in economic growth
- Index funds, diversification, low fees, long horizon
- You’re not trying to be smart, you’re trying to not be stupid
- Accessible to anyone, scales infinitely, requires almost no skill
- The boring correct answer for most people
If you want to be ahead of the crowd in any game, you need to understand what the beta is,
First principles of markets
A market is a mechanism where buyers and sellers can find each other and exchange something at an agreed price.
An ‘efficient’ market is one where all existing information is incorporated into the price of the market for that thing.
An Aside on the grossman-stiglitz paradox; if markets are perfectly efficient, then all information would be priced in, so no one should trade because it’s EV negative.
Markets naturally evolve with time and changing circumstances;
- Inefficiency appears in a market
- Inefficiency attracts sophisticated traders
- Sophisticated traders compete away the inefficiency
- Repeat
Inefficiency typically manifests in mis-pricing. (whether that’s you buying a juice box at the grocery store or VCs burning capital on overpriced AI companies)
If you don’t know why the inefficiency exists and persists, you probably haven’t found it.
Further, An edge could be the discovery and exploitation of inefficiency. Not all edges are sustainable.
types of markets
There are order driven and quote driven markets.
Order driven markets are where participants gather and trade with each other. (ebay)
Quote driven markets are where professionals offer quotes and takers take those prices. (The restaurant selling passionfruit juice, or a currency exchange booth at the airport)
On Price;
A price is very useful and almost always correct given the circumstances.
A price tells you what the sellers think is EV positive for them to sell at. If you’re buying, you think the seller is wrong.
A price allegedly encapsulates the consensus view of all currently available information, “what everyone else thinks”.
All events are new information (merger, dividend, etc.) When new information is available, the price changes (obviously).
Therefore, the price chart tells you, what historically the available information has been, and you can learn when different information was likely priced in.
market knowledge
When making an investment decision (buy / sell), you are trading against a participant who is presumably very informed.
The only way to make money is for you to think that the price of something is wrong. Which means that all consensus informed participants must also be wrong. You must know something everyone else doesn’t, and be right that everyone else doesn’t know it.
The seller only sets the price. As the taker, you set the time AND the price.
basic structural reality in light of the above
The foundational lesson from the above is to look for markets where there are more likely to be inefficiencies. And try to be really good in those obscure areas. The riches are in the niches as they say.
Understand the game you’re playing
Globally speaking, think about who you’re competing against, if the average global IQ is around 85 [1], that means a random human competing with you can’t do basic algebra.
In the United States, average IQ is 97 [2], which is globally average [3].
Setup the game so that you’re more likely to win. Think carefully about which games / businesses and careers are EV positive, then when you choose to get involved, understand carefully what all possible outcomes really are and how many of those outcomes are ones you want and how much you have to commit and sacrifice to play those games.
Then do what you can to increase the number of the good outcomes and reduce the number of bad outcomes. Easier said than done!
Be a big fish in a small pond
Small capacity strategies, by definition are too small to move the needle for very sophisticated large players.
For example, trading micro-cap value stocks. You can’t lever strategies up much because the markets are too small and the companies don’t have as much data for automated large players to get involved.
I guess that means everyone in Hong Kong should be trading on the NEPSE. There are probably good reasons that isn’t happening but that’s beside the point.
Do lots of reps, any random niche seems hard at first but not later
It’s been very well studied that reps are the most important thing to reducing effort per complex task AND increasing overall mental endurance. Use this fact to your advantage. Pick a unique area and try it lots of different times and ways, eventually each attempt gets easier, and trust me, small bits and pieces will start to work. I promise you.
The difficulty curve of doing anything is more like a gamma distribution, difficult at first with high variance because you can’t imagine what the 50th time looks like. The good news again is you get to pick what you work on, so just doing the work and struggling a little at first will get you there. Just make sure you pick a problem or task where the you will find the value there.
References
[1] https://www.researchgate.net/publication/397690959_National_IQs_measurement_and_defense
[2] https://www.mastermindbehavior.com/post/what-is-the-average-iq
[3] https://en.wikipedia.org/wiki/IQ_classification
P.S. one last thing, make a spreadsheet of your utility metrics and check it every 2 weeks! You should outline your goals as a subset, then start charting. Would love to see someone show me a SMA chart of their optionality or something cool like that.
If anyone’s interested, email / DM me and I’ll make a template goals sheet.