Patsy in the Game

May 21, 2019    notes

Via Prof Sanjay Bakshi:


  1. “Patsy” is defined as someone who is “easily taken advantage of, especially by being cheated or blamed for something.”

  2. “naïvety” is defined as “ a state of having a lack of experience, understanding or sophistication, often in a context where one NEGLECTS PRAGMATISM IN FAVOR OF MORAL IDEALISM”

  3. They means that a naïve man believes that the world is a fair and moral place and he is not being fooled, even when the odds of that happening are monumentally higher than those of the other alternative.

This man is not “PRAGMATIC,” a term that’s defined as someone who “evaluates theories or beliefs in terms of the success of their practical application.” That is, a naïve man is not a practical man who would see the world as it truly is. Such a naïve man is “morally idealistic” who does not assume ulterior motives in others when he deals with others.

Being naïve in life in general may not cause you much harm if you’re lucky. But being naïve in financial markets virtually guarantees significant harm, and even ruin.

Games for Patsies

  1. IPOs

    • If you are buying into IPOs, you are a pasty in the game. Why?
      • Information Asymmetry. The insiders know more than you. You are not an insider.
      • Timing. They decide when to come to market and will come only in “more favorable” circumstance. “Less favorable” for you.
      • Scarcity. Create artificial scarcity by limiting the quantity of shares and the hype.
  2. Heavy Promotions

    • Anything that’s being heavily promoted where the person doing the promotion has financial incentive to pitch you, even if the product is unsuitable, is toxic
    • Case in point: Most investment advice. All over-promotional managements talking up stock, indulge in aggressive accounting to trap investors.Most credit rating opinions and audit opinions.
    • Default position you should take is not to trust them blindly. If you, then you are the patsy in the game.
  3. Spotting Frauds

    • People who are pragmatic and do not take anything at face value, and are not prone to give into what Robert Cialdini calls “authority bias” and bias from “social proof,” are well positioned to spot frauds well before other “believers” who will turn out to be patsies in the game.
    • Case in point: Here, Markopolos is Fat Tony. He doesn’t believe other investors. He doesn’t believe the auditors. He doesn’t believe the claimed performance. Indeed, he thinks the performance is just too good to be true. And he believes that if something’s too good to be true (like landing 99 heads in a row in a “fair” coin), then it probably is.
  4. You Fooling Yourself

    • Patsy in the Game: That game can be a single player game.
    • Richard Feynman was right when he said that “the first principle is that you must not fool yourself and you are the easiest person to fool.

Take for example of what happens when you are invested in something and new evidence comes that ruins your hypothesis. Maybe the business is no longer as good as you thought. Maybe the management is really not as good as you thought or maybe the valuation model was wrong. There could be so many reasons which can ruin any investment hypothesis. The correct thing to do, in such situations, is to recognize the mistake, scramble out of it, and then try not to make that type of mistake again.

Well, the normal outcome, as many of us know, is the opposite. And this happens for reasons we may label as “commitment bias,” “endowment effect,” “psychological denial,” “blind overconfidence” etc etc. We may give this type of tendency all sorts of names, but the reality is that we are really good at fooling ourselves into believing the unbelievable despite contrary evidence.

When we choose to ignore overwhelming evidence showing that we were wrong and continue to stay invested in situations which just don’t make sense anymore, how different are we from that naïve school kid who continued to believe that the coin was fair even after it had landed heads 99 times in a row?

We are not that different at all. And by not being different from that naïve kid, we become a patsy in the game.