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the psychology of successful trading Trading trading psychology

The Halo Effect is One Cause of the Bitcoin Bubble

What is the Halo Effect?

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The Halo Effect occurs when people judge the overall quality of an item or person by considering only a single property of that item.  This can lead to dramatic errors; most obviously when all of the other qualities of the item  are negative or highly questionable.  This I will argue here is one causal factor among several which have caused novice investors to buy Bitcoin.  When it crashes, they will lose all of their money.  They will be unable to exit the market because the power of the cognitive bias is too strong.

In this post, I will briefly set out the cognitive biases which are in play here before describing the Halo Effect and how it is another feature of human psychology which leads people to mistakenly buy Bitcoin.

Why People Like Bitcoin

The Halo Effect is not the only causal factor operative among the novice investors who are buying Bitcoin.  I have already argued elsewhere that another causal element is that Bitcoin buyers prefer their own experiences to any consideration of statistical data. In addition, Bitcoin buyers share with Trump voters a distrust of experts, as I have also argued elsewhere.

We can see that as a two variants of the Dunning Kruger effect.  Here, people who lack competence are unable to detect such lack of competence. This makes intuitive sense since people who lack competence and are aware of it would presumably either take steps to address that lack or avoid activity requiring the relevant competence.

https://www.psychologytoday.com/gb/basics/dunning-kruger-effect

A corollary of that is seen in another variant of the Dunning Kruger effect. People who lack expertise are unable to detect true expertise.  We can see this when someone is able to publish a book on Bitcoin when it is quite apparent that they do not have even a basic understanding of it.  For readers of this book, it must be impossible to recognise and benefit from well sourced, properly constructed arguments, for example in the mainstream media.

Origins of the Halo Effect

The Halo Effect was first seen in data about personality assessment in the military.  Officers asked to rate their subordinates would in fact rely on a single criterion. They would then assume that all other relevant factors were correlated with that one criterion.  This is obviously dramatically false unless all of the other variables are correlated with the one assessed.  And that is highly unlikely to be true.

False Claims About Bitcoin

Many people are unable to distinguish Bitcoin from the blockchain.  This leads many of the novice investors who are buying Bitcoin to fail to distinguish between the two claims “I am buying Bitcoin” and “I am investing in blockchain technology.”

The blockchain is a distributed ledger system which offers transparent recording of transactions (or any data) without the backing of any central authority.  It is an extremely interesting technology which holds great promise.  It could create corruption-resistant property ledgers.  That would be of great benefit, not least in combatting money laundering.

Bitcoin is termed a “cryptocurrency” even though it does not fulfil the roles of a currency in that it is not readily convertible and it is not a stable store of value.  It rewards the miners who maintain the blockchain on a widely dispersed set of servers.  However, it is clear that the blockchain and Bitcoin are not identical.

So this is how the Halo Effect kills traders. They confuse a potential positive quality with all properties. Bitcoin uses the Blockchain. The Blockchain is interesting. Therefore Bitcoin is interesting as an investment. This does not work even if it is true that the Blockchain is interesting. And even that claim is highly questionable.

A Potential Response From Bitcoin Proponents

An objection has been attempted here by a Bitcoin proponent that it is not possible to have a blockchain without a cryptocurrency.  There are a number of readings of that, but on the obvious two, the claim is either false, or true but misleading.  If the claim means “you cannot run blockchain code without also generating a cryptocurrency” then it is false. Blockchain code could run with the cryptocurrency elements redacted. Or they could have zero value, which achieves the same thing.

If the claim means “it is necessary to compensate the miners, ” then it is true.   However, the miners could get $.  Or the blockchain could run in the cloud, or in many clouds.  That would carry some costs, but this is not a problem.  It would even be possible to compensate the miners in a cryptocurrency which was pegged against the $.  There is no need for the cryptocurrency to appreciate and definitely not to gyrate wildly.  I therefore conclude that the objection fails.

Why All This Means Bitcoin is Toast

There is one positive property that Bitcoin possesses.  It is true that it is generated using the blockchain technology.  It is also true that the blockchain technology is extremely interesting, and being pursued widely by a number of serious players.  By contrast, no professional, experienced or institutional investor is holding Bitcoin.  Novice investors fall prey to the Halo Effect when they think that the one positive quality of Bitcoin is a measure of its overall quality, when in fact it has no other redeeming features at all.  This will prove to be a very expensive cognitive bias when the Bitcoin crash comes.

See Also:

The Forthcoming #Bitcoin Crash Will Kill The #Trump Demographic

The #Anecdotal Fallacy And The #Bitcoin Bubble

Bad Arguments for the Permanence of Bitcoin

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the psychology of successful trading Trading trading psychology

The Bitcoin Crash Will Kill The Trump Demographic

Introduction

We know that if you voted for Trump, you are more likely to be less intelligent, less educated, poorer and more rural.  I will argue that this leads to a further feature — distrust of experts — which is required to be a supported of either Trump or Bitcoin.  This suggests that the Bitcoin Crash will kill the Trump demographic.

Note that I said “more likely to be []…”  We are talking about two curves here.  It is not certain that you are less intelligent and poorer etc.  It would not be an objection here to say “I have a PhD and I am rich and I voted for Trump.”  To say that would be to commit the Anecdotal Fallacy, which I argued yesterday is also a major feature of the Bitcoin bubble.

Only Amateurs Do Not Expect a Bitcoin Crash

One of the notable points about Bitcoin is that there are no professional, experienced or institutional investors who have invested in Bitcoin.  If that changes, we should all become seriously concerned.

Everyone who holds Bitcoin is an inexperienced amateur.  I put this to a Bitcoin enthusiast, and received the following reply.

Mark Cuban invested big into Unikorn. Peter Thiel invested into bitpay which is a wallet company. Mike Novogratz (former president of fortress investments and partner at Goldman Sachs) runs Galaxy Investments (almost exclusively crypto). Tim Draper bought 30,000 btc in 2014.  And Bill Gates: there are no definitive articles on how much BTC he holds but he has plenty of quotes talking about how it’s the future

I will now show why none of that works.

Mark Cuban and Unikorn

The first point to make here is that it is odd to cite Cuban here since he is on record as saying that Bitcoin is a bubble.  The other problem is that Unikoin, the token involved in this ICO, is not Bitcoin.  (I also believe that almost all of the other ICOs are fraudulent, but I would need a lot more space and time to show that.)  Finally, Unikoin will apparently permit sports betting, so while I do not recommend that, it at least has a theoretical source of value.  Bitcoin does not.

Novogratz

Novogratz and Galaxy Investment Partners have invested into the huge and under the radar Worldwide Asset eXchange (WAX).  This is like selling shovels to miners in the Klondike gold rush.  (Reportedly, Trump’s grandfather ran a Klondike brothel.)  Selling shovels is a great business to be in, irrespective of how many of the miners or Bitcoin holders go bust.  So this again is not an example of a major investor holding Bitcoin.

Tim Draper and 30,000 btc

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This is the only one of the examples which approaches being serious.  We must take it seriously because Draper reportedly invested serious money: $18m.  And he is actually holding Bitcoin as opposed to backing exchanges.  The caveats though are manifold.  First, he lost 40,000 Bitcoin in the Mt Gox fraud, and the fact that this did not give him pause makes me think he is an esoteric thinker.  Secondly, a lot of his remarks concern enthusiasm “for the technology”.  It is very important to keep a clear distinction between Bitcoin — a Ponzi scheme — and the block chain — a very interesting technology.  Thirdly, this is one man against every investment bank, hedge fund, regulator and all the other expert investors in the world.

Discrediting Experts as Diagnostic

I have in fact been told that my 20 year experience of successful investing is a disadvantage, because it means I am unable to understand the “glorious opportunity” allegedly represented by Bitcoin.  There are in fact some advantages to disadvantages, as I argue in my new book:

https://www.amazon.co.uk/Psychology-Successful-Trading-Behavioural-Profitability-ebook/dp/B07885RH42

— but that isn’t one of them.

Bill Gates and the Bitcoin Crash

This is an excellent example of muddled analysis and poor understanding of the importance of precision and sourcing one’s quotes from reputable sources.  (It is no coincidence that Bitcoin supporters and Trump voters alike disparage proper news sources like the New York Times and prefer websites with manufactured quotes.)  We are not actually given a quote from Gates which is the first problem.  

But secondly, it is highly likely that even if Gates thinks the blockchain is the (part of) the future, he is not holding any sizeable numbers of Bitcoin.  Why would he? He does not need to to look at blockchain technologies and he knows that a Bitcoin crash is inevitable.

A distributed transparent ledger, which is what the blockchain is, is indeed a highly interesting piece of technology which would have many very useful applications.  As just one example, imagine replacing property registers with blockchain.  Myriad opportunities for money laundering and corruption would disappear, and be replaced with an efficient technology. The fact that Bitcoin is also built on the blockchain is irrelevant.

Conclusions: Bitcoin Crash Will Kill The Trump Demographic

So none of the arguments described above succeed. They do nothing to deny that the Bitcoin Crash will kill the Trump demographic.

People in this country have had enough of experts

This is actually a quotation from a pro-Brexit politician, but we see the same pattern across the Brexit “debate,” in Trump vs Clinton, in global warming and in MMR Vaccine/autism.  In each case, you need to believe that you are right and anyone educated or with specialist knowledge is wrong.  You also need to believe that those people are lying to you — for no obvious reason.

The quality of the arguments raised by Bitcoin proponents can be seen to be extremely poor.

So now you can decide.  If you invest in Bitcoin, you are lining up with the people who mistrust experts.  If you voted Trump, you did the same thing, because you are probably a climate change denier.  So I think there is a very strong likelihood that many Trump voters are also holding Bitcoin.  

And they are going to pay a heavy price for both decisions. The only thing that will save them somewhat is they are poor. So they won’t lose that much in absolute terms. But it might still be a lot for them.

See Also:

The #Bitcoin Bubble Is Caused By The Halo Effect

The #Anecdotal Fallacy And The #Bitcoin Bubble

Bad Arguments for the Permanence of Bitcoin

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

Categories
the psychology of successful trading Trading trading psychology

Bitcoin Bubble: Caused By The Anecdotal Fallacy

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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!

Categories
the psychology of successful trading

Bitcoin Has No Future

Bad Arguments for the Permanence of Bitcoin

I will argue that Bitcoin has no future. I will do that by rebutting various elements of a rather poor article arguing that Bitcoin will be around forever. It appeared here:

https://www.theguardian.com/commentisfree/2017/sep/15/jp-morgan-ceo-wrong-bitcoin-jamie-dimon

The random banker bashing in the headline might give you an initial suspicion about who is likely to be right here.

The first rhetorical question the article asks is “Would Jamie Dimon really sack traders who netted a 1,000% return in less than two years? The bank’s shareholders wouldn’t approve”

The answer to this is definitely yes.  Return alone is an inadequate assessment of trader performance.  We must look at risk-adjusted return. A guaranteed 10% return is better than anything lower than a 50% chance of 20%.  If the trader made his 1000% by betting on a single horse, he took an enormous risk to make his 1000%. The shareholders would certainly approve of Dimon sacking such a trader and in fact would demand it.

Bitcoin Has No Future: Standard “Fake News” Accusation

Next is a ‘fake news’ type criticism aiming to show that Dimon is biased.  He writes “Although JP Morgan was by no means the most leveraged of the banks, it still took bailout money, and, as its CEO, Dimon and bitcoin will inevitably be philosophically opposed.” 

These claims don’t stack up.  Firstly, JP received a bail out post-crisis (fine).  Secondly, Bitcoin is a response to this crisis. I doubt it, but let’s accept this.  Thirdly, JP oppose all crisis responses.  Conclusion: JP opposes Bitcoin forever.  Premise Three is obviously false. It has no defences.

The next section of the article accuses Dimon of not understanding Bitcoin because he says it is a fraud.  The author then admits that the main uses of Bitcoin are for fraudulent and criminal purposes but it is not itself a fraud.  This is parallel to those arguments against gun control which say that guns don’t kill people, people do. This is another obviously stupid argument.

The Weakest Point of the Argument

I will close by criticising a remarkable paragraph which packs in a lot of errors and bad arguments.

“Dimon declares that we will use the technology – blockchain technology – but that bitcoin will be shut down. That’s like saying we will use football pitches, but football players will be banned. One comes with the other. In any case, you can’t just shut bitcoin down. It’s a decentralised, distributed network. That’s the whole point of its design. There is no central point of failure.”

Frisby
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Objections to the Football Analogy

This is very strange.  Take the football analogy first.  There are two major problems with it.  As a parallel, it may or may not work.  Assume it works.  Let’s be generous. 

There are alternative uses for football pitches.  Other sports exists. They became holding centres post-Katrina.  Other uses are possible.  We could land helicopters on them.  So even if Bitcoin ls like playing football and the blockchain is like a football pitch, we can do other things with football pitches and we could do other things with the blockchain.  Strikingly in fact, this is where much of the excitement exists.  There are many potential extremely useful applications of a distributed ledger technology such as property registers and shareholder transaction records.  These would be interesting because they would be highly transparent and resistant to corruption and bureaucratic sloth.

Bitcoin Has No Future: You Can Have a Blockchain Without Bitcoin

The claim that you can’t have a blockchain without bitcoin is false. You do need to pay the miners. But you could pay them dollars. Moreover, that argument needs the blockchain to be useful. That is possible but the jury is still out. So that argument does not work against the claim that Bitcoin has no future.

The second argument in here is equally poor.  It claims Bitcoin is impossible to shut down because it is decentralised.  What this means is that you cannot shut down the servers behind Bitcoin because they are decentralised.  But that isn’t what Dimon says.  He says that “There will be no currency that gets around government controls.” What if governments made Bitcoin possession and use illegal and banned its use in any transactions?  They could do that and then what Dimon has pointed out is true. But no-one has to go around shutting down distributed servers.

Conclusions

I conclude that the author has done nothing to show that Dimon is wrong. So we can be clear that Bitcoin has no future.

See also:

The #Bitcoin Bubble Is Caused By The Halo Effect

The Forthcoming #Bitcoin Crash Will Kill The #Trump Demographic

The #Anecdotal Fallacy And The #Bitcoin Bubble

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