If you’ve read the book, Bringing Down the House, where a blackjack playing team from MIT was able to rake in millions playing blackjack, you are probably aware that it is possible to beat blackjack. However, the catch is most people are not able to beat the game because of the concept of Gambler’s Ruin. Simply stated, in an even or positive expectation game, the person with the largest bankroll will win all of the money (for those of you math fanatics, theoretically there exists a bankroll program that will avoid Gambler’s Ruin, but for most humans it is very difficult to be that disciplined). Let’s take for a quick example that I’m willing to play heads/tails with you. Heads - you win 10 times your bet and Tails - you lose 1 times your bet. You gather all the money you have because this is a great, fun game, right?! You bet $1,000 and you win $10,000, then you decide to keep pressing your luck and bet everything again and you win $100,000, etc. Because the game is so fun and profitable, you keep pressing your bet/luck. Guess what happens? Eventually, you will lose everything on one roll and I will win assuming I have a monster bankroll. In this super simple example even though you have a positive expectation, you will end up with zero because I have a significantly larger bankroll. If you’re not careful, gambler’s ruin can also cripple your business.
As an entrepreneur, we’re all risk takers and risk seekers. It’s not much different than taking a high volatility bet on a penny stock which has the potential to go to zero or the moon. I’ve mentioned it many times, it’s very important to get in the game first and take the plunge. Once you’ve taken the plunge, watch out for gambler’s ruin when competing against the big guys. The big competitors have more resources, more time, more money - they are the HOUSE! You cannot beat the house at their own game. In fact, if you try, you’ll lose in the long run even if you win a few small battles. You have to change the game. You need to be the house and force them to play your game.
What is your game? It is a more focused game, a tightly defined set of customers and products - more defined than your competitors. Google competed against Microsoft by focusing on search, they defined the search game. They laser-focused on the product that was just plain better than Microsoft and won the search game. Yelp took on Citysearch by focusing on a customer set that was professionals (yuppies) from San Francisco and killed it. Define your product and customer set as laser-focused as you can and you’ll start winning the game. The big guys can’t afford to do it because the numbers just don’t move the needle for them, they need to aim bigger and focus less. By the time they realize what’s happened, it’s too late, you’ve already won.
So, get out there and create a new game and don’t get tricked into playing the big guys game and lose. It’s time to bring down the HOUSE!
This is a great post Andy. You did a great job of packing a lot of thought into 3 paragraphs.
Great post Andy. On the other hand, I’d be glad to play heads/tails with you any time
like it, very information and helpful, I wish you’d post more often. Really motivating and I relate to it.
Excellent post. I have a mentor that is similar to you and he is really big into poker and poker theory. His house is riddled with poker strategy books. It appears that young entrepreneurs seem to gravitate towards gaming strategy as many of the lessons one learns from it can be applied to life and business.
Agreed. Staying focused is essential.
What is everyone else’s background on here? I’m the CEO of a new start-up called Workyourcareer.com (formerly Moneybackjobs.com).
I agree 100%. Grabbing a small niche and owning that niche can be rewarding for you when it doesn’t make sense for the big guys.
If you are innovative enough you can even make that small niche a large niche and effectively grow your own pie.
@Mark Thomas - I am a researcher by day, and small niche builder by night & early morning.
I completely agree with owning a niche. Once you find one that is profitable and has very little competition you need to make if your own.
I believe the point of your article is that it can be correct for an entrepreneur to pass up on certain positive expectation situations if the financial outlay is too great and/or the chance of success too small. An entrepreneur, like a gambler, has to evaluate not only the expectation of a wager but also its results profile, ie. get filthy rich 1%, break even 20%, be homeless 79%.
Your example of Gambler’s Ruin is a poor one, and in any case does not apply to the point you want to make. Kelly Criterion is the concept that is relevant here (and one you alluded to).
A superb summary of Gambler’s Ruin, Andy. In my trading, I never risk more than 2% of my account in a trade for that very reason — the markets are stranger than anyone can imagine, and One Fine Day the market may go against me 10 times (or more) in a row even with a good strategy, so I need enough capital to ride that out. Limiting the risk in a trade is one way to preserve capital.
I disagree with a previous poster that Kelly Criterion (http://en.wikipedia.org/wiki/Kelly_criterion) is the right term to use. Kelly Criterion is about the optimal bet size for long term gain, but IMHO isn’t always appropriate in a real market.
It’s *exactly* the right concept.
Why do you risk a maximum 2% of your account on on a trade? Why 2%? Why not 10, 20, 100%? If something is a 2% trade for you, then why is a trade that may be slightly better also a 2% trade? Kelly Criterion deals specifically with these concepts.
The only limitations it has in a “real market” are the limitations upon your analytical skills and creativity in order to apply it.
It is far from a “superb” summary of Gambler’s Ruin. He provides an outrageous example (betting your entire bankroll on a coin flip ad infinitum until failure) of something no reasonable person would ever do — metaphorically or otherwise.
The final three paragraphs provide the nuggets of wisdom; I take issue with all the crap preceding it.
Great Analogy! People do need to be wiser when making big decisions these days, especially the way the economy has been going!