Original article by Felipe Montealegre
Compiled by Odaily Planet Daily Golem (@web3_golem)
While economics studies rational actors who make optimal decisions and reach a precise equilibrium, algorithmic game theory seeks to understand whether humans following simple rules can make decisions that are close to optimal. The process of “regret minimization” can help us understand when and how to converge on optimal decisions through simple rules.
It turns out that humans become better at making decisions if they “torture” themselves with regret after making mistakes. Anyone who has learned a new skill can observe this process. When you play Catan, think about why you shouldn’t focus on sheep, because the price of wool will inevitably fall as the game enters the city-building phase; when you play tennis, learn not to hit backhand winners, especially when you are tired. This knowledge is accumulated through the process of regret minimization, making your game closer and closer to the effective frontier of your ability.
We are in the middle of a rampaging bull run, and many of us wake up every morning feeling sorry for ourselves when we see a token we don’t own go up 150% or sometimes 1500%. Maybe one of your good friends recommended it to you last week, and you even saved multiple posts about it. You may have seen it on TikTok and thought to yourself “I can understand young people liking this kind of thing.” So, are your regrets a healthy exercise in regret minimization that makes you a better investor, or should you be more nuanced in your self-flagellation?
Three Types of Regret
There are three types of regret, and you should treat each type of regret differently in the process of minimizing regret.
External Regret
External regret means that you feel afterwards that you made the wrong choice. Like in Texas Hold’em, you have a pair of Aces and choose to go all-in (Odaily Note: A pair of Aces is the largest starting pair in Texas Hold’em) , but the person next to you bets on a full house on the last card (Odaily Note: three cards with the same 1 point, which is higher than a pair) ; or when you go to a nearby Chinese restaurant for dinner but find that it is not so good, you will also feel external regret. You should have gone to a different restaurant that you chose before, but you couldn’t know it in advance.
As a fundamental investor, you also feel extrinsic regret when you miss out on XRP. Wouldn’t it be nice to get a 5x gain in 15 days? Extrinsic regret is a poor way to learn in hindsight. In a probabilistic world, anything can happen, and you can’t afford to feel regret for every missed opportunity, or you’ll abandon the discipline you’ve built around a consistent, thoughtful investing philosophy.
Degradation Regret
The fundamental question is not whether you should buy XRP, but whether you should change the trading principles that lead you not to buy XRP. This is where Swap Regret comes into play.
Degrading regret means you regret following a rule and wish you had changed it for a better one . When you play poker and you bet big on a 7 and a 4 even though there are two aces on the table, just because you are tired of folding, that is degrading regret. You followed the rule of “bet big when you are bored”, and you have reason to change this suboptimal rule to some other rule about optimal poker play at any time.
When Warren Buffett moved from “cigar butt investing” to compound investing, he was learning to degrade regret and replace one rule (buy relatively cheap assets) with a better rule (buy growing businesses with strong moats). In the example of external regret, you would not experience degraded regret in the Chinese restaurant example above unless you decided to change your rule from “I will try new restaurants” to “stick only to restaurants I already like.” Degraded regret is a great way to learn—you constantly review the rules you follow when making decisions and ask yourself if there is a rule that would lead to a better outcome.
If you want to do proper regret minimization on XRP, you need to ask yourself if there are better rules that will allow you to make a purchase decision next time. Potential options include – “When an old friend texts me that a certain coin is going to soar, I should buy it” and “I should buy the coin that sees rapid growth on TikTok.” Many people are currently trying to do this type of regret-reducing learning.
I can’t think of any good rules that fit into my investment philosophy and made me decide to invest in XRP, so I don’t regret missing it. You can only feel degradation regret when you are willing to change the rules that govern your behavior.
Regret
Degrading regret is the core concept, and internal regret is relatively easy to understand.
Internal regret means you are not executing your own rules. You will feel internal regret when you are a “paper hand” and sell at the bottom of the SOL, even though you told yourself that you are a contrarian investor who is willing to hold on through a big correction. Druckenmiller knew it was a mistake when he bought at the top of the tech bubble in 2001, even though he realized it at the time. You should not hesitate to flagellate yourself for internal regret and learn some trading discipline of your own.