A nice mental model in poker is to measure your profits in “Sklansky dollars” instead of real dollars. A Sklansky dollar is the expected value from a play if you knew what every other player held.
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Sports betters can use a similar heuristic. Instead of measuring profit in real dollars, assume the odds immediately before the start of the game are accurate, and measure your profit in terms of how much the odds moved in your favour from when you bet to when the game started.
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By removing the randomness from the game from your measurement, you can zero in much faster on your true edge and calibrate your bet size and frequency more appropriately.
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An application in finance is transaction cost analysis. If you measure execution slippage vs arrival price, it’s very noisy. Instead measure it vs a VWAP over your execution window, or if measuring slippage in single names, adjust the benchmark to take account of how much the …
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…index or sector moved over the execution window. There are similar techniques for measuring the quality of your alphas.
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The general principle is that if you need to measure something noisy, and there is value in converging more quickly on the right answer, it almost always pays to spend time reducing the randomness of your measurement as much as you can.
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