Game Theory is an area of applied mathematics that studies the optimal strategies in various situations normally used as a tool in decision making. It is very popular among economists. However, it has also gained quite a bit of ground in other fields. It helps us to understand more deeply human behavior in social and economic interactions.
The word “game” could be misleading. Certainly, Game Theory is applicable for playful activities. However, it is also extremely useful in the financial markets, in politics, in war, and in many other areas. Any interaction with others that involves incentives, losses, gains, actions and reactions could be called a game in the context of the theory. I mean, Game Theory is not a game. This is serious and extremely powerful.
Now, I remind my esteemed audience that this is an opinion piece. It is not an encyclopedic article on the concept: Game Theory. It is not a Wiki. In fact, I am not an expert on the subject. MMy intention here is to introduce the concept, accompanied by some personal considerations, with the purpose of stimulating better financial strategies among Bitcoin investors.
Here the goal, as investors, is to make money. As simple as that. This is the incentive of this game. Money is made by buying low and selling high. The challenge of this game is that success does not depend on us. That is, the market as a whole is the one that has the last word. We can buy, sell or wait. Beyond that, we are at the mercy of the market. The price may go up. The price can go down. Or the price can remain stable. It does not depend on us. If we buy and the price goes up, we win. If we buy and the price goes down, we lose. If we buy and the price stays the same, we neither win nor lose.
The key question: What do I think others will do? Whoever gets it right wins. The one who anticipates the behavior of the majority, gets the prize. To illustrate this complication, I will use the famous Keynes Beauty Contest. If someone has to choose the most beautiful candidate among a selection of contestants, the voter is most likely to be carried away by her personal tastes. However, the winner will be the one that gets the most votes.
Suppose now that the organizers of the contest decide to reward the voters who voted for the winner. In this case, our strategy would be different. In other words, we would no longer vote according to our tastes. In this case, the most sensible thing would be to vote for the taste of the average. Here the challenge would be to anticipate the majority taste, because the incentive is based on getting the majority vote right. Well, markets work like this.
When it is said that an investor should invest with a cool head, it is being suggested that the investor should largely ignore their personal emotions, tastes and aspirations. For the same reason that we shouldn’t vote for the most beautiful contestant with a personal bias, you should invest thinking about the probable behavior of the market. We may or may not agree with the market. It does not matter. The strategy is designed to win. If the intention is to win, we must play the game by the rules.
In cryptoland, there are many lovers. There are many people who fall in love with the social movement, because the movement gives them a new identity. Bitcoin offers them a narrative, some friends and some enemies. It gives them a cause and makes them heroes of a story. So, many take their savings and invest in a code with an illusion. Lights are placed in the eyes. They become active members of Twitter. And they begin to fight against the system and promote a libertarian utopia with Bitcoin as their messiah. In the process, due to ideological bias, financial education and risk management are often neglected.
“Now I understand the problem of money,” announces a tweeter. “The only risk is not buying Bitcoin,” writes another tweeter. Basically, they are slogans and phrases that are repeated ad nauseam. In most cases, these are people educated by YouTube and Twitter. This community of believers is created, because it is business to have a community of believers. “Bitcoin is the money of the future.” “Bitcoin is scarce.” “Bitcoin will be worth a million dollars.” “Bitcoin fix this”. “Bitcoin has the most powerful computer network in the world.” I am afraid that in these cases it is about people who are voting for the most beautiful contestant according to their personal criteria.
What is the key question? The key question: What do I think others will do? In this sense, we must be as realistic as possible. If we want to win the prize, we must study others and ignore our personal tastes and aspirations. In other words, we must stop repeating slogans and prefabricated scripts to put the emphasis on financial education and risk management.
What is the minimax principle? As far as possible, the best strategy is always to minimize losses. I mean, it’s always good to be prepared for the worst case scenario. It must be invested defensively. Which is my stop loss? What happens if Bitcoin goes to zero? What is my risk? Which is my hedge? What percentage of my portfolio do I have in Bitcoin? How do I manage volatility? What happens if all my predictions fail?
A Bitcoin fanatic usually doesn’t care about things like financial education or risk management. What risk? What financial education? Your confident ignorance allows you to have all the answers. Resorting to the propaganda script is enough for the fanatic. These are short and catchy phrases applicable to any situation. Fanaticism is a consolation for many, because it represents psychological strength. An iron faith. Everything is safe, simple and definitive. Everything belongs to the field of the absolute.
The investor, however, is not in the business of faith. His business is to make money. Which means you need to be as objective and pragmatic as possible. That implies that he must know his risks and must manage them in the best possible way. I add here the links of other articles of my authorship related to risk management. I invite you to investigate further on the subject.
One final note: Unrealized losses are also losses. On the one hand, they remind us that we buy expensive. On the other hand, recovery takes time. And time is money. He mentioned that last one, because phrases like “long-term investing” are often abused in this space. It is often implied that long-term investors should not manage their risks. And they just have to wait with their arms crossed for recovery. I’m afraid this is not entirely accurate. Every investor must manage their risks.
Disclaimer: The information and/or opinions expressed in this article do not necessarily represent the views or editorial line of Cointelegraph. The information set forth herein should not be taken as financial advice or investment recommendation. All investment and commercial movement involve risks and it is the responsibility of each person to do their due research before making an investment decision.
It may interest you:
Investments in crypto assets are not regulated. They may not be suitable for retail investors and the full amount invested may be lost. The services or products offered are not aimed at or accessible to investors in Spain.