Please note the following System Requirements. Further, please limit the number of open applications (particularly price streaming applications) while logged in to Alpha Theory™.

Recommended System Specifications
Processor: Dual Core or Quad-Core 2.4GHz or faster
Browser: Google Chrome 30+
Screen Resolution: 1280 x 1024 or greater
Internet Access: Business Class High-Speed

Minimum System Requirements
Processor: Intel Pentium-M 2.0Ghz or equivalent
Browser: Google Chrome, Mozilla Firefox, Internet Explorer 9+ (without Compatibility View), Safari
Screen Resolution: 1024 x 768 or greater
Internet Access: High-Speed

Alpha Theory Blog - News and Insights

August 18, 2017

Man Versus Model of Man: Lewis Goldberg

I recently read an article by Jason Zweig and saw a reference to Lewis Goldberg’s, “Man Versus Model of Man” paper on Expert Studies in the 1970 Psychological Bulletin. There are hundreds of published studies that have a similar theme. Give an expert any and all available data that they want and ask them to make a judgement germane to their field of expertise (examples include Oncologist – how long will a patient live, Parole Board – who is most likely to recidivate, Wine Expert – price of wine at auction, etc.)

The experts tell the scientist which variables are most important in their decision and the scientist goes off and builds a model and compares the model’s results to the forecasts of the “experts.” Over the past 60 years, hundreds of expert studies have been performed and show that the model beats or ties the expert 94% of the time (1).

There was one of Goldberg’s quote about the use of models versus clinical decision making made me laugh:

Such an enterprise, originally viewed with considerable disdain by clinical psychologists, has recently weathered a period of intense controversy (Gough, 1962; Meehl, 1954; Sawyer, 1966), and may soon become a reasonably well accepted procedure in psychology—if not in medicine, stock forecasting, and other professional endeavors.

Consequently, it now seems safe to assert rather dogmatically that when acceptable criterion information is available, the proper role of the human in the decision-making process is that of a scientist: (a) discovering or identifying new cues which will improve predictive accuracy, and (b) constructing new sorts of systematic procedures for combining predictors in increasingly more optimal ways.

This quote was written 46 years ago yet clinical judgement still dominates psychology, medicine, and stock forecasting. Given the evidence, it is hard to argue against model-based decision making or man + model, but expert judgement still dominates.

The experts that will dominate the future (and are already beginning to do so) are the ones that embrace models as an extension of their own expertise. Models do not replacement human judgement. The parameters models are built upon are determined by experts. Experts also are required to intuit when exceptions to the model are necessary.

My belief is that Lewis Goldberg’s prediction will come true in the next decade as computing power, statistical techniques, software, and zeitgeist have grown to a point where Man + Machine will become the rule instead of the exception.

Here’s a few other great quotes from Lewis Goldberg’s article:

- Mathematical representations of such clinical judges can often be constructed to capture critical aspects of their judgmental strategies.

- The results of these analyses indicate that for this diagnostic task models of the men are generally more valid than the men themselves. Moreover, the finding occurred even when the models were constructed on a small set of cases, and then man and model competed on a completely new set.

- Ten years of research on the clinical judgment process have demonstrated that for many types of common clinical decisions and for many sorts of clinical judges, a simple linear regression equation can be constructed which will predict the responses of a judge at approximately the level of his own reliability. For documentation of this assertion and for details of the methodology, see Hoffman (1960), Hammond, Hursch, and Todd (1964), Naylor and Wherry (1965), and Goldberg (1968). While such regression models have 424 LEWIS R. GOLDBERG been utilized (probably somewhat inappropriately) to explain the manner in which clinicians combine cues in making their diagnostic and prognostic decisions (see Green, 1968; Hoffman, 1968), there is little controversy about their power as predictors of the clinical judgments


(1) “Comparative Efficiency of Informal and Formal Prediction Procedures” – William Grove and Paul Meehl, published in Psychology, Public Policy, and Law (1996)

July 28, 2017

Crist on Value

There is a paper, famous in value investing circles, called Crist on Value. It is a chapter from a book written by horse handicapper Steven Crist who opines on the short-comings of the average horse bettor. Its popularity amongst value investors is due to its sage advice that can readily be applied to investing. The article is of moderate length and a must read for any fundamental investor. I’ve taken the liberty of highlighting a few of quotes pertinent to our profession:

- “How often have you or a fellow track-goer opined that you're a pretty good handicapper but you really need to work on your betting strategies or your so-called money management? The problem with this line of thinking is that it suggests betting is some small component of the game, which is like pretending that putting is a minor part of championship golf.” INVESTOR CORROLARY: Investors that believe they are good stock pickers but just don’t get the position size right.

- “Even a horse with a very high likelihood of winning can be either a very good or a very bad bet, and the difference between the two is determined by only one thing: the odds. A horseplayer cannot remind himself of this simple truth too often, and it can be reduced to the following equation: Value = Probability x Price." INVESTOR CORROLARY: Investments decision process requires three components: profit from win, cost from loss, and probabilities of each.

- “Now ask yourself honestly: Do you really think this way when you're handicapping (in probability-weighted returns)? Or do you find horses you "like" and hope for the best on price? Most honest players will admit they follow the latter path. This is the way we all have been conditioned to think: Find the winner, then bet. Know your horses and the money will take care of itself.” INVESTOR CORROLARY: Every investment requires story and value. With both, you don’t have an investment.

- “Sticking to your guns is easier said than done, but it is the only way to win in the long run. The horseplayer who wants to show a profit must adopt a cold-blooded and unsentimental approach to the game that is at variance with both the "sporting" impulse to be loyal to your favorite horses and the egotistical impulse to stick with your initial selection at any price. This approach requires the confidence and Zen-like temperament to endure watching victories at unacceptably low prices by such horses.” INVESTOR CORROLARY: If you’re human, you’re subject to bias and emotion. Define rules and procedures in advance that highlight discrepancies between your actions and your rules.

- “I cannot argue in good conscience that Two Item Limit had precisely a 60 percent chance of victory as opposed to 57 or 63 percent, and I doubt that such calibration is in fact achievable. It is, however, possible through experience to get close enough that if you demand sufficient value to cover the margin of error, you should outperform the competition-your fellow horseplayers.” INVESTOR CORROLARY: Coming up with probabilities for stock price outcomes are even more subjective, but that doesn’t mean you can skip the exercise. Play around with a range of outcomes and figure out what is “too conservative” and “too aggressive” to give you comfort for where the probability should be.

 - “If every horseplayer but you were a certifiable idiot, betting at random on names and colors, you would win every day. Conversely, if the only people betting into the pool were the small number of professionals who make a living this way, your chances for long-term victory would be slim.” INVESTOR CORROLARY: How does your competition in the stock market stack up today?

- “Your opportunity for profit at the racetrack consists entirely of mistakes that your competition makes in assessing each horse's probability of winning.” INVESTOR CORROLARY: While we look at the move to passive as a negative; more passive money should increase the number of opportunities for active investors.

- “There is no shame in passing a race because you just don't see any value in it. Nor should you force yourself to play a race in which you have no confidence in your own odds line.” INVESTOR CORROLARY: Good ideas are hard to find, but worth the wait.

- “Recognize the difference between picking horses and making wagers in which you have an edge. The only path to consistent profit is to exploit the discrepancy between the true likelihood of an outcome and the odds being offered.” INVESTOR CORROLARY: Probability-weighted return is the arbiter of all decisions.