Using behavioral finance in sports betting Part I

Why do sensible and generally rational people sometimes make foolish and irrational decisions when it comes to sports betting? Concepts from the field of psychology, called behavioral finance in the investing world, can be useful in describing the traps that often ensnare bettors and can hopefully help readers make more reasonable choices in their own betting. It may be a bit long and some dry reading but you should grind through it (several times actually) to gain an insight into what it is saying and develop your knowledge from there.

Due to the scope of the concept I will break it into small installments over the coming days to make it easier to digest for those who may not have been exposed to these concepts previously.

Essentially behavioral finance says that the human thinking process does not work like a computer but instead processes information using shortcuts and emotional filters. An investor/bettor that is aware of these psychological biases and works to minimize their affect on his decision making will have a decided edge over the majority of the public money that does not. That is the point I hopefully communicate in every post on this blog, how to use concepts from other disciplines (mainly finance) to improve your betting results.

Prospect Theory
The traditional view of human behavior is that people are always rational when it comes to financial decisions. This normative (description of what people should do) approach tells how people should act in order to maximize wealth. It is the underlying assumption that has allowed to field of finance to develop portfolio theory, CAPM, arbitrage theory and option pricing theory. In contrast to this view of what people should do, behavioral finance studies how people actually behave when money is on the line.

One important concept to understand in Prospect Theory is called anchoring. Anchoring is simply a strong mental attachment to a certain price. It is important to remember because the founders of Prospect theory, Kahneman and Tversky, use it to illustrate a subtle yet powerful behavior that is insightful for bettors.

The idea is that essentially bettors/investors are happy with say a $100 win but not twice as happy with the next $100 they win and likewise on the down side. Bettors feel pain for the $100 loss but not twice as much with the next $100 lost. The downside is however much more powerful than the upside.

In the betting world we have all heard the phrase “let your winners run and cut your losses short” well Prospect theory starts to shed light into why otherwise rational human beings have so much difficulty actually executing this simple concept. Put simply, people hate to lose money more than they like to win it!

“So how in the hell does this help me make money, oh long winded one?” asks the dubious and bored reader. I’ll tell you. One of the worst things I see bettors do on an almost nightly basis is try chase their losses on a late game. They are anchored to a number which was their bankroll size at the beginning of the day and when it goes down they feel the pain of loss more so than they would feel the satisfaction of a gain and instead of simply shrugging their shoulders and chalking it up to the nature of sports betting they try and make it all back with a big hit at the end of the night. The flaws in this behavior are obvious, the bettor ends up putting a larger than optimal percent of their new bankroll size at risk in a spot that is probably less than a great value. In fact they probably wouldn’t have played the game at all if it were at say 7:00 instead of 11:30!

So the next time you feel the urge to chase, remember Prospect Theory. Everyone feels these urges from Wall Street to Vegas to a dorm room, the pro’s have the self awareness and discipline to avoid acting on the urge to chase. If you want to stop losing in big chunks on a bad night you need to develop this discipline yourself!

More next time and until then, as always Best of Luck in whatever you play!