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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

Cognitive Biases And Stock Markets

What is a Cognitive Bias?

A Cognitive Bias is an element in our psychology which makes decisions for us.  In fact, given there are so many of them, you might even say that our psychology is just Cognitive Biases.  I discuss about 20 of them and give market context in my new book:

https://www.routledge.com/The-Psychology-of-Successful-Trading-Behavioral-Strategies-for-Profitability/Short/p/book/9781138096288

One example which I discussed in a previous post is Hindsight Bias.  This makes us think that everything which has happened was inevitable.  This in turn makes us very bad at knowing what level of probability we assigned to past events.   We seem to remember that we said that a prior event was going to occur with 90% probability when in fact, we gave it a probability of 30% before that event occurred.  This will obviously have unhelpful effects in the context of markets.  It will make us greatly overestimate our chances of knowing what is going to happen next, which may make us trade with over-confidence.  There is nothing quite like over-confidence to kill market performance.

Learn More About Cognitive Biases

As I said, the book covers around 20 biases and their effects in markets in much more detail than I can give above.  The thing is though, that there are way more biases than that.  In fact, in the chart below, you can see just how many there are.

Every one of these biases will affect your market thinking and that of everyone else involved.  So it looks like we all have some work to do!

In the links below I give you more information about a wide set of cognitive biases. These are all in addition to the ones I cover in the book. Many of them are very surprising.

See Also:

#Narcissism and #Unexpected Behaviour

The Illusory Truth Effect And Financial Markets

If You Like Gin And Marmite, You Are Probably A Better Trader

The Late Evaluation Effect And Financial Markets

The #Bitcoin Bubble Is Caused By The Halo Effect

The #Anecdotal Fallacy And The #Bitcoin Bubble

The Picture Superiority Effect And Financial Markets

Negativity Bias And Financial Markets