I began my career in finance in 1987 as a stockbroker at Drexel Burnham, back in the days of Michael Milken. I then traded exotic derivatives at Credit Suisse before there were standard pricing models. I ran currency option trading globally for Bank of America and emerging markets for AIG International. I spent 12 years as a global macro hedge fund portfolio manager, directly overseeing as much as $916 million in assets under management, and I founded and ran two hedge funds.

At about the same time I entered the industry, I began studying the cognitive sciences, particularly behavioral psychology and decision theory. So, as I was developing my own style, my own unique approach to investment and business management, I would apply everything I was learning about how the brain works, how we approach problems and make decisions to solve them.

As it turns out, when you do that, you wind up doing things very differently than most. But it wasn't just the approach that made me unique; it was the results it delivered that truly set me apart. For instance, in the first 12 months after I took over at Bank of America, we increased revenues by 70% without increasing costs at all. We did so on the back of a marginal adjustment to the way we made decisions as a group. In my first year running emerging markets for AIG International, we went from being the worst performing unit in the business to the best, as a result of a marginal adjustment to the way we approached problems. Over a 12‐year career as a global macro hedge fund manager, I generated 20.3% average annualized returns spanning quiet markets, high‐volatility periods, and chaotic moments, with a Sortino ratio that was twice my Sharpe.

When I took the helm at one hedge fund, we were on the brink of failure. We had let go all nonessential personnel, cut salaries to the bone, and hadn't raised a penny in assets since launch nor made a penny for our investors. Over the next 13 months, we increased assets under management 12‐fold, from $100 million to $1.25 billion, beat our benchmark index by 2500 basis points net of fees, and every single portfolio manager had his career best year – all because of a few marginal adjustments to our decision‐making process.

As happy as I have been with the results, anyone who has studied decision‐making knows that what I've just listed are outcomes. We don't control outcomes. What we do control are all the tiny little decisions that we make along the way. Decisions that must be made rationally in order to improve the odds of achieving the outcomes we desire.

The majority of books on the subject of cognitive science focus on presenting evidence of our flaws. I don't want to discount the value of that evidence. It is essential material, for unless we accept that we are all susceptible to bias and other shortcomings that unconsciously lead to systematic errors in judgment, it is nearly impossible to overcome it. If you can't overcome it, you are as good as you will ever be.

AlphaBrain differs from the other books in that it applies these abstract, seemingly academic concepts to the industry of institutional investment management, but takes it one step further. Rather than simply make readers aware of our flaws, we will explore actual solutions to real world problems. Instead of reading yet another book on cognitive bias, then setting it down and going about your business in exactly the same way as you had been, you should expect to set the book down numerous times in order to contemplate your own actions as an institutional investor, and begin implementing real change. In order for that to happen, for you to experience a leap forward in the evolution of your decision‐making, I must first convince you that you are as vulnerable to those mistakes as every other human being. The fact that you are likely very intelligent, well educated, experienced, and perhaps successful already, it makes my job that much more difficult.

I know from experience how difficult it is to read the works of Kahneman, Ariely, and Tversky, and see yourself as their flawed subjects, but until you do, the odds of you actually learning from it and experiencing that leap forward are drastically reduced. Let me share with you how I made the leap.

How a Mistake Made Me a Better Investor

Daniel Kahneman, one of the leading experts in cognitive psychology and author of some of the most widely read books on the subject, discusses the futility of teaching his findings in a section of Thinking, Fast and Slow, titled “Can Psychology Be Taught?” You'll have to read the book to learn why he came to “the uncomfortable conclusion that teaching psychology is mostly a waste of time,” but I will share with you how I arrived at that same conclusion, as well as the mistake I made more than 20 years ago that enabled me to break through the barrier, shifting from a spectator to a practitioner.

One of the fundamental tenets of cognitive psychology is that we essentially have two systems at work in our brain. Kahneman calls them “System 1 and System 2,” although Richard Thaler and Cass Sunstein refer to them as “Planner and Doer.” What you call them isn't nearly as important as recognizing that there is a part of your cognition that is automated, intuitive, and quick to draw conclusions, whereas the other part is more deliberate, methodical, and intellectually demanding. When you read about these abstract characters, you may or may not agree that they relate to you, but you undoubtedly recognize their existence in others. Even if you do see these two distinct systems playing a role in your decision‐making, it's unlikely you could do so in real time. Of course, with the benefit of hindsight, your task is made much simpler.

If your decision resulted in an unfavorable outcome, you are likely to attribute the decision to System 1 thinking, a temporary lapse in judgment, bad luck, or perhaps another person. If the result is positive, of course, we rarely seek an external source to apportion credit, least of all, luck.

In the moment, though, when we are gathering information, interpreting it, processing it, drawing conclusions from it or making decisions based upon it, it is almost impossible for us to recognize whether we are employing mental shortcuts that are likely to result in a systematic error in judgment or if we are objectively analyzing the situation, drawing upon our wealth of knowledge and experience to reach a thoughtful conclusion. I mean, how do you define an action as dogmatic versus disciplined, before the outcome is known? How do you differentiate between an impulsive decision and one based on educated intuition until after the result is experienced? The truth is, although the difference may appear glaringly obvious with the benefit of hindsight, it can only truly be objectively judged at the moment of inception. Those who have difficulty coming to terms with that subtle, yet significant difference likely have a great distance to cover before becoming practitioners of cognitive science themselves.

So, how was I able to make the leap from someone who had spent years simply studying the cognitive sciences to becoming a practitioner? I owe it all to my mother‐in‐law and a simple mistake I made on March 24, 1994. I know the exact date because it occurred in the hospital, one day after my first child was born. My mother‐in‐law asked if I'd like something for lunch and I gave her my order. Forty‐five minutes later, she returned, handing me a sandwich and saying, “Here's your veal parmigiana hero.” My hand automatically jerked away. “I didn't order a veal parmigiana hero,” I stated emphatically. She insisted I had and we went back and forth before I finally introduced reason to the rhetoric.

I explained that while the veal parmigiana hero had been one of my favorite foods as a kid, after seeing a video years earlier which showed how calves are treated in order to make veal, I had made a conscious decision never to eat veal again – which is how I knew beyond the shadow of a doubt that I hadn't ordered a veal parmigiana hero this time. She apologized, I skipped lunch, and life went on.

A few months later my wife and I looked through pictures from the birth, as well as video we had taken around that time. That's when my life changed forever. It turns out that someone had been taking video in the room when I gave my lunch order. On the screen, I saw a person who looked just like me, and who sounded just like me say to my mother‐in‐law, “I'll have a veal parmigiana hero, please.” It was like an out‐of‐body experience. I get chills to this day when I think about it. Immediately, my mind attempted to make sense of it all. Someone dubbed over my voice. Someone doctored the tape. Someone went to a lot of trouble to make me look foolish. The truth, of course, was a whole lot simpler, and there was no getting around it. In that moment when I had ordered the sandwich, my mind was engaged elsewhere, and that left System 1 or the “Doer” alone to hear the question, interpret it, process it, and answer it, all without me even being aware. You see, veal occupied a much greater portion of my memory than did eggplant. Avoiding veal was a conscious decision, but on that day my choice had been made unconsciously, even though I was wide awake and conversing. The result was a mistake, a poor decision, yet I had no idea I had made it and without the video evidence I would forever believe I was in the right and my mother‐in‐law had been at fault.

That was the last time I have ever felt 100% sure about anything that relied on my memory. It's also the moment when I truly understood what Kahneman, Thaler, Sunstein, and others meant in all those books, and rather than treating mistakes like these as remote possibilities, I came to see them as facts of life. If I was going to avoid them, I would have to make my vulnerability a fundamental part of my assumptions, and make the appropriate adjustments to my decision‐making process.