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Bitcoin Bubble: Caused By The Anecdotal Fallacy

The Anecdotal Fallacy, where people privilege their own experience over statistics, is one of the many cognitive biases that infect our thinking. It is particularly dangerous in financial markets, as illustrated by the current bubble in Bitcoin

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There is currently a huge Bitcoin Bubble.  BTC actually has zero value so any trading at a non-zero value represents a bubble.  I will suggest here that the reason for this strange development is a cognitive bias known as The Anecdotal Fallacy.

What Is The Anecdotal Fallacy?

The Anecdotal Fallacy occurs when people ignore statistics and quote a story of events that happened to them.  Often, it will turn out not even to have even happened to them, but to “someone they know.”  While this step is an additional move away from constituting useful data, it is not the worst effect of this bias.  The main problem is that assessing probabilities on the basis of personal experiences is almost completely useless.  This is true even when those personal experiences actually occurred.

There is only one way to assess probabilities, and that is to use statistics on similar events.  This is hard.  In fact, even understanding it when it has been competently done by scientists or statisticians is hard.  It needs a lot of training and it seems as though our psychology is almost designed to trip us up.

The Anecdotal Fallacy is widespread.  Its use seems in many circumstances to be almost automatic.  If you give most people data on a topic, people will generally respond with what they think is a counterargument from their own experience.  Apparently intelligent and successful people fall into this error, so those qualities won’t help you.  For example, Rupert Murdoch recently tweeted a photo accompanied by the text: “Just flying over N Atlantic 300 miles of ice. Global warming!”

How Does The Anecdotal Fallacy Drive the Bitcoin Bubble?

This is a fairly extreme example which may have been deliberately provocative, but it is also quite stupid.  There are two mistakes here. One is the idea that global warming has to have happened already in all locations.  The second is that global warming would eliminate all ice on the planet.  These mistakes show a non-existent understanding of the problem.  The only way to assess the probability that global warming is a genuine threat is to look at graphs showing correlations between greenhouse gases in the atmosphere and temperature rises over several decades.*  Any personal experience is simply irrelevant to that task.

We also tend to over-estimate the probability of vivid events.  I see This as an aspect of the Availability Heuristic, which I think is related to the Anecdotal Fallacy.  We use the Availability Heuristic when we assess the probability of events by considering how hard it is to think of an example of that type of event.  Obviously we will make errors in probability judgment if some events are easier to recall than others, and more vivid events are more easy to recall.  I discuss this aspect of our psychology in the context of financial markets in my new book:

Why is the Anecdotal Fallacy relevant to the Bitcoin Bubble?

Everyone who is buying Bitcoin is doing so based on one of two events.  Either they have recently made a large amount of money from buying it or someone they know says they have.  Twitter is full of stories of people claiming they have made money.  This is vivid and alluring.  It draws more people in, which of course is what helps to sustain the Bitcoin Bubble.

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The problem is not that these stories are false.  A lot of people have indeed made a lot of money out of Bitcoin.  However, it is still a terrible investment.  In fact, I don’t think we can even call it an investment.  It has no fundamental value.  So it can crash to zero at any moment.  It will definitely do so; we just don’t know when.  So the problem is rather that people are using the Anecdotal Fallacy to assess the probability of Bitcoin rising.  They are wrongly thinking Bitcoin will rise forever.

What Should We Think About Bitcoin?

People making this mistake are forgetting the bubbles which have often happened in financial history.  Any “asset” which rises this quickly has been a bubble.  It has eventually crashed to zero.  It will do so as quickly as it went up.

The statistics are completely opposed to our psychology here.  Stay away from Bitcoin at all costs.

*The reason I say “several decades” is because we have only been taking detailed measurements for about 150 years.  However, we have data from ice cores etc going back much further.

See also:

The #Bitcoin Bubble Is Caused By The Halo Effect

Bad Arguments for the Permanence of Bitcoin

The Forthcoming #Bitcoin Crash Will Kill The #Trump Demographic

The Psychology of Successful Trading: see clip below of me explaining my new book!

By Tim Short

I am a former investment banking and securitisation specialist, having spent nearly a decade on the trading floor of several international investment banks. Throughout my career, I worked closely with syndicate/traders in order to establish the types of paper which would trade well and gained significant and broad experience in financial markets.
Many people have trading experience similar to the above. What marks me out is what I did next. I decided to pursue my interest in philosophy at Doctoral level, specialising in the psychology of how we predict and explain the behaviour of others, and in particular, the errors or biases we are prone to in that process. I have used my experience to write The Psychology of Successful Trading. In this book, I combine the above experience and knowledge to show how biases can lead to inaccurate predictions of the behaviour of other market participants, and how remedying those biases can lead to better predictions and major profits. Learn more on the About Me page.