It began with this text from my wife. “Jackson (our son) wants to buy an extra Austin City Limits ticket to sell later on, presumably for a profit. What do you think?” I’ll be honest. For years, I’ve been trying to find a way to teach my kids about trading in a way that would capture their interest. Finally, I had my opportunity. I said, “Yes, but it’s not a gift, it’s an investment that he will make from his savings.” As I talked through all of the issues and decisional aspects of the investment, it dawned on me, this would make for a great Seeds piece, as well. So, here it is. I should preface the following by stating up front, reselling tickets for a profit is legal in the state of Texas. Jackson’s argument for purchasing the extra ticket for $255 is that every year he sees tickets sell in the online aftermarket “at the last minute for as much as $500.” If he could do that, he would effectively be able to go for free. That’s when I let him know that he was trading. He was making a bet based on his experience. He had identified a trend in price action and was positioning himself to capitalize on it. Right off the bat, he had made a classic mistake by framing the decision irrationally. He is correct, he could effectively go for free, but because money is fungible, the cost of the ticket he is actually using is completely irrelevant. All that matters is how much he is risking relative to how much profit he expects to gain. It’s a mistake that traders often make (see “Half Off” in Auditing Mental Accounting).
He acknowledged that there was a risk that he wouldn’t be able to sell the ticket for at least what he’d paid, which is the lowest he’d be willing to sell it. By refusing to sell it for less than he paid, he is effectively saying he’d rather lose everything, than lose even a little bit. As is often the case with traders, he saw that risk as something close to zero. Even if that’s the case, the price he paid for the ticket is irrelevant going forward. It means nothing to other concertgoers, and should mean nothing to him either. From that point forward, he is simply trying to maximize his return.
His argument for getting into the trade is sound. Every year the tickets sell out within two days, and he just bought one more ticket than he had in any other year. “So you could assume that there's at least one person who's normally getting a ticket, that was unable to.” If you think about it, he’s talking about market positioning now. There are two issues with this logic. First, he has ignored the fact that there is also at least one person who normally buys just one ticket, who now has two. So, while demand may have grown by one, so too has supply. This has implications for the second issue.
As it is for traders, he doesn’t have perfect information about market positioning. How many others have purchased extra tickets for the sole purpose of selling at a higher price? How many are professionals? What is their risk tolerance? How quickly does the excess demand normally get satisfied? In other words, what is the optimal time to sell? That doesn’t necessarily mean the highest price, but that point where the reward relative to risk has peaked. “You're playing to people's need to not be left out of stuff and the closer it gets, the more of a panic people get into.” He’s right, but again, he’s ignoring the supply side which will feel the same pressure. The longer he waits, the more desperate potential buyers become, but if he waits even a minute too long, the ticket will be worthless, and so at some point, that puts pressure on sellers.
“However, when all of the other people doing this put tickets on sale for $500, if I'm desperate, I can put mine up for $400, still make money and have a definite sale since its $100 less than competitors.” On paper, as a hypothetical, this strategy appears sound, but only because it glosses over some very difficult to define, yet essential aspects of the decision process. How do you define desperate? Will you know when you have become desperate, and if so, will you be able to contain the emotion so that you can still make a rational decision? I suggested to him, what I suggest to all of my clients. Make a plan ahead of time. Set reassessment triggers in both price and time, up front before emotion takes over. In other words, rather than trying to sell at the absolute high, set a price target and stick to it. If the target isn’t hit by a particular date, resolve to sell it then, at the clearing price.
There is one final, but very important point which came to light when he said, “I saw one go for $650 last year which is absurd.” He says it is absurd, but because he didn’t sell his ticket for $650, he effectively paid $650 for the ticket he used. Therefore, he has defined his own action as absurd. How did I arrive at this conclusion?
He has a ticket. That ticket could be sold for $650. Therefore, there is no difference between $650 cash and the ticket. If instead of holding that ticket which represents $650, he was actually in possession of $650 cash (and no ticket), he could not attend the concert. However, to get back to holding a ticket, he would have to exchange that $650 in cash for it. Therefore, he paid $650 for his ticket. My son remains unconvinced, but he’s not alone.
I wrote about a similar story to this one in Auditing Mental Accounting, where Richard Thaler and Eldar Shafir asked wine connoisseurs how much they paid for a bottle of wine in the following situation. Suppose you bought a case of a good 1982 Bordeaux in the futures market for $20 a bottle. The wine now sells at auction for $75 per bottle. You have decided to drink a bottle. Which of the following best captures your feeling of the cost to you of drinking this bottle?
$20 plus interest
-$55 (I drank a $75 bottle for which I only paid $20)
Interestingly, respondents were fairly evenly dispersed with the percentages for each answer being 30%, 18%, 7%, 20% and 25%, respectively. Put another way, in the mind of more than half the respondents, drinking the wine either cost them nothing or it actually saved them money. The researchers found the results so fascinating, they followed up a year later with a related experiment. Their findings were later published in a paper with the very literal title, “Invest Now, Drink Later, Spend Never.” It should be noted, the great majority of respondents were people whom most would consider to be financially sophisticated individuals, including many professional investment managers and economists. (The correct answer is $75.)
About the Author For nearly thirty years, Stephen Duneier has applied cognitive science to investment and business management. The result has been the turnaround of numerous institutional trading businesses, career best returns for experienced portfolio managers who have adopted his methods, the development of a $1.25 billion dollar hedge fund and 20.3% average annualized returns as a global macro portfolio manager.
Mr. Duneier teaches graduate courses on Decision Analysis in the College of Engineering, as well as Behavioral Investing, at the University of California.
Through Bija Advisors' coaching, workshops and publications, he helps the world's most successful and experienced investment managers improve performance by applying proven, proprietary decision-making methods to their own processes.
Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America, Managing Director in charge of Emerging Markets at AIG International and founding partner of award winning hedge funds, Grant Capital Partners and Bija Capital Management. As a speaker, Stephen has delivered informative and inspirational talks to audiences around the world for more than 20 years on topics including global macro economic themes, how cognitive science can improve performance and the keys to living a more deliberate life. Each is delivered via highly entertaining stories that inevitably lead to further conversation, and ultimately, better results.
His artwork has been featured in international publications and on television programs around the world, is represented by the renowned gallery, Sullivan Goss and earned him more than 50,000 followers across social media. As Commissioner of the League of Professional Educators, Duneier is using cognitive science to alter the landscape of American K-12 education. He received his master's degree in finance and economics from New York University's Stern School of Business.
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