Last week I ended with a somewhat oblique reference to poker; an Ace and a picture card versus a pair of 5’s.
My reason for doing so is I have been reading about and thinking about gambling a lot lately….and my wife is terrified.
Gambling, like most events in life that involve uncertainty and risk, is all about probability…and probability is all about statistics. The easy thing about most forms of gambling is the statistics are simple.
There are a defined number of desirable outcomes amongst a larger set of definable potential outcomes. It then becomes a question of working out the most probable of the desirable outcomes given your knowledge of the game itself, as well as the state of the game at any point in time.
And the number of possible outcomes isn’t that large.
Just remember, the most critical element in this or any gambling scenario is what you know. Not what you think you know, but what you definitely know.
Let me provide an example. This year’s AFL Grand Final where there were only three possible outcomes; a Sydney win, a Hawthorn win or a draw.
Now, pre-game what did you know? Well, let’s divide what you knew into the rational, and the gut feel categories:
- Two teams were involved meaning there were three potential outcomes;
- A draw was much less likely than either side winning;
- Hawthorn led the league in averages for total disposals, goals scored, effective disposals and goal assists;
- Sydney led the league in averages for contested possessions and tackles;
- Sydney had beaten Hawthorn by 19 points in round 8;
- Hawthorn had beaten Sydney by 10 points in round 18;
- Sydney had a 2 and 1 win/loss record at the MCG in 2014; and
- Hawthorn had a 10 and 1 win/loss record at the MCG in 2014.
On the basis of the rational data I would probably bet on Hawthorn beating Sydney for the flag.
Now for the “gut feel” data:
- Hawthorn had won the flag in 2013 and had far greater big match experience;
- Hawthorn had had injury problems but had a full list for the Grand Final;
- Sydney had no injury problems pre-game.
- Sydney had thumped North Melbourne in the Preliminary Final the week before;
- Hawthorn had barely scraped through the Preliminary Final over Port Adelaide;
- Sydney looked confident;
- Hawthorn looked tired and nervous.
On the basis of the above data I would back Sydney to win the flag 6 days out of 7, and that’s what most punters did, with the talking heads on Channel 7 announcing that on the morning of the Grand Final there hadn’t in recent memory been a shorter priced favourite on Grand Final Day than Sydney.
Now, the factor that obviously carried the most weight in everyone’s mind was Sydney’s thumping of North Melbourne. Now, there’s no question there is a correlation between strong performance in a Preliminary Final and performance in the Grand Final, but is it strong enough to outweigh the rational data listed above?
All the rational data was completely forgotten by most punters as they watched the Minor Premiers destroy the 6th placed team at home in Sydney.
But then, you would expect that result wouldn’t you?
Conversely, Hawthorn struggled to beat the 3rd placed Port Adelaide. Or rather, a gutsy Hawthorn held off a fast finishing Port Adelaide who for a long period in the middle of the season were first on the ladder.
On the morning of the Grand Final when Hawthorn were paying $2.50 for the win I thought to myself “The markets got this one wrong. That’s too long. I should take that bet.” But I didn’t….
I am no gambler.
So, what’s the point I am trying to make?
That decision making hinges on focussing on what you know, steadily updating your opinion of the probable outcome as more information comes to hand…and critically evaluating all new information. Is it relevant, reliable?
The reason for bringing up poker is it is another game of uncertainty and statistics where decision making is, on average, poor purely because knowledge of the probabilities is minimal.
This is where what you know becomes critical.
And for most poker players, all they know is Ace is good, 2 is bad. Full house beats a flush beats a straight beats…
Add to that the fact most people tend to play poker when three sheets to the wind, and the average poker game becomes an exhibition in how NOT to make decisions.
But what do you know?
Let’s return to my final point from last week’s Update; betting big on an Ace and picture card (not of the same suit), but playing cautious with a pair of 5’s.
What would you do? If you are like most people you would probably bet big if you were dealt the Ace and picture card.
Now, for those into poker, I am talking about Texas Hold ‘em here. For those not into poker, Texas Hold ‘em involves each player being dealt two cards on which each player bets.
Following the close of betting on the two cards dealt, three cards are then placed face up on the table for all players to use. Following rounds of betting, a fourth and then a fifth card are placed face up on the table.
With that in mind…
Here are the probabilities of being dealt a pair of any kind, or a non-suited Ace and picture card:
Pair: 220:1 or 0.045% probability of being dealt
Ace High (Non suited): 19:1 or 4.9% probability of being dealt
And here is the head to head probability of a win in a couple of different scenarios:
Pair vs 1 over card (Ace) and 1 undercard: 1: 2.5 or 71% probability the pair wins
Pair vs 2 over cards: 1:1.2 or 55% probability the pair wins
So, it’s rare to be dealt any kind of pair…and they tend to win hands more often than not. Sure, a pair will get beaten by almost any other good hand, but the good hands just don’t get dealt very often.
And yet, most players wait for the good hands because they don’t understand the statistics and then probabilities of getting a pair, let alone a pair of Aces.
From an economist’s perspective this makes me think about a perfectly competitive market. Remember from a few months ago? A perfectly competitive market means perfect information that is available to all?
Well, using poker as our analogy, how do you know your cards are good? How do you know the information you have is reliable and relevant, and how do you know others in the market haven’t already taken advantage of that information?
Tough questions. And in truth, there is no simple answer. In the real world you will rarely have 100% confidence that what you have been told or seen is true, and this is where you return to statistics and probability. You can infer on the basis of the evidence available that it is more or less likely that what you have heard or seen is true.
Hardly the type of conclusion to engender confidence, but then, sometimes you have to back yourself.
Returning to the topic of the talk given by Bernard Salt a week or so ago, he was addressing a room full of people who had WA-specific knowledge of finance and the property market in particular.
Yet, he sounded so knowledgeable and confident that by the end of the talk when fielding questions he had property specialists asking him what he thought the prospects over the next 12 to 24 months were for specific properties in the Perth metro area!!!
Now, I may be a cynic, but here is a guy who lives on the east coast, is an accountant by training, writes books and is a professional speaker. WHAT would he know about the prospects for Alkimos over the next 12 months????
And this is why most poker players are waiting to be dealt a pair of Aces. Because our understanding of probability, and confidence in the data we obtain, is so low that we are always seeking the sure thing, the soothsayer who can tell us what is going to happen.
I gotta tell ya, they don’t exist, at least not for a broad market.
This brings me to the property market, and a chat I had earlier last week with a friend who is a real estate agent we will call The Agent (I know, not very imaginative).
The Agent said she hated it when there were references to “the market” and what “the market” was doing as, in The Agent’s and my opinion, there is no market. It’s not some large, ponderous animal that moves slowly in a single direction at one time. It’s a fractured assembly of thousands of little markets comprising single suburbs and a lot of the time, bits of suburb, that move on their own in their own directions based on the impact of a number of factors.
And this is where knowledge has always played a part. Specific knowledge, insider’s knowledge…at least if an investor was hoping to make serious money.
What type of knowledge? Well, as an example:
- Zoning that was about to change, allowing greater subdivision;
- Plans for local infrastructure that would potentially improve local values; or
- Sale of a property is by a mortgagee in possession (bank sale).
And what’s serious money? I would have thought a 20% capital gain in 12 months as a baseline. A minimum 20% return was the “hurdle rate” used by property finance when I was a part of the BIG BANK so we’ll use that number.
So, you want to win the hand. Make the right bet. But how do you know if you have good cards? Particularly if you are new to the game?
Now the good news.
We are now in the era of Big Data where there is more information available in the public domain than ever before in human history, and the quality of that data is improving dramatically. The issue though has been whether or not the data has been reliable.
That’s because in many cases the data has been just opinion, not empirical. Text, not numbers.
BUT, it appears what has happened over the past couple of years is it has become apparent how powerful statistics are and as a result they have become cool (at least in my warped definition of “cool”).
Websites are being simplified and made easier to navigate and the data provided is now largely reliable.
The Real Estate Institute of WA (REIWA) website has been relaunched and the WA Market tab is a portal into some detailed information in table form regarding every suburb in the metro area, as well as every regional area.
Have a look. Play around.
That website will provide information regarding the direction of the various mini-markets, as well as the features of those mini-markets such as average age, number of residents, number of sales over the past 12 months, et cetera.
The next source of data comes courtesy of another friend who is a consultant whom we will call The Environmentalist.
The Environmentalist loves data, a beer, and a beer and a chat about data. He does me the great courtesy of reading the Update and was good enough to send me a blog and suggest I subscribe, which I did.
The blog is part of the Urban Development Institute of Australia, Western Australia website. Just Google UDIA.
This site provides updates on statutory plans, developments, announcements that might once have only been available to those inside the property industry….and that’s how the website markets itself, as a site for the property industry.
That’s a good start. Two sources of reliable data that might make you feel like you have reasonable cards.
Food for thought….