Disclaimer: This is not financial advice. I am not a financial advisor. What follows is my personal, subjective, biased opinion.

The News

On Wednesday, Reddit user jackfaker shared a graphic matching Bitcoin’s price to popular Reddit headlines in the past two months. As it turns out, bullish reports have made the front page of r/cryptocurrency all the way through the big 70% market drop that followed January’s massive bull run.

While some posters have indeed managed to time their analysis well, most can now easily be called out for having been blatantly wrong.

The Facts

The cryptocurrency subreddit has over 630,000 subscribers. A post with 100+ upvotes can expect to get several thousand views and anywhere from a few dozen to a few hundred comments. From checking the community almost daily for the past eight months, I can confirm that ‘bullish reports’ make the front page close to every day.

Meanwhile, both Bitcoin in specific and the overall cryptocurrency market are down about 60% from their respective all-time highs of $20,000 and $800 billion in mid-December and mid-January.

The Commentary

In most financial markets people care more about being right rather than making money. Whether it’s the stock market, tech trend predictions, real estate value appreciation, or cryptocurrency prices, there is no lack of people claiming to know where we’re headed and no lack of evidence to prove them wrong, time and again. While some of the reasons are obvious, like vested interests, others aren’t.

It’s hard to compare predictions of a large in-group, like r/cryptocurrency, to a large out-group, like non-investors, due to the latter’s lack of interest in the subject matter. However, in Fooled By Randomness, Nassim Nicholas Taleb makes an example that shows we can assume even completely uninformed individuals would stack up comparatively well if they invested in crypto.

Starting from a random sample of 10,000 investment managers:

“The Monte Carlo generator will toss a coin; heads and the manager will make $10,000 over the year, tails and he will lose $10,000. We run it for the first year. At the end of the year, we expect 5,000 managers to be up $10,000 each, and 5,000 to be down $10,000. Now we run the game a second year. Again, we can expect 2,500 managers to be up two years in a row; another year, 1,250; a fourth one, 625; a fifth, 313. We have now, simply in a fair game, 313 managers who made money for five years in a row. Out of pure luck.”

Photo by Michał Parzuchowski on Unsplash

That’s why some of the world’s best investors take little credit: they know luck remains a large factor, because markets are big and uncontrollable. Hence, they’re happy to set up a system, make decisions based on a set of rules, then let time show the results.

Amateur investors, on the other hand, tend to overvalue their own ability to pick good investments and undervalue how little predictions matter. As a result, they check, they predict, and they’re constantly stressed. While innumerable cognitive biases are at play here, a mixture of the following nine contributes a large chunk to false predictions and the bad moods that follow from them.

1. Skin In The Game

The most obvious reason it’s hard for investors to judge markets objectively is that it is in their best interest for whatever they invested in to go up in value. Nassim Taleb’s latest book, Skin In The Game, defines this as not just an incentive for gain, but also a disincentive for failure. In relation to financial markets:

“If you give an opinion, and someone follows it, you are morally obligated to be, yourself, exposed to its consequences. In case you are giving economic views: Don’t tell me what you “think,” just tell me what’s in your portfolio.”

If you own Bitcoin, of course you will jump on any shred of news that hints at the fact Bitcoin’s price might go up. And if you own a whole variety of coins, the same applies to news regarding the overall market. What’s more, the predictor is likely to have the same vested interest, hence his or her prediction.

2. Evasive Optimism

I could’ve labeled this ‘escapism,’ but in the special case of investing, bear market predictions don’t really provide psychological refuge, they just add more stress. When someone comes out and says “we’re about to enter a bull market,” however, that’s relieving.

The crypto market has been in a rough patch for two months. The longer tough markets last, the harder it gets for investors to hold on to their coins. Reality is too depressing, so what better distraction than to research a bunch of random facts, mesh them together, and arrive at the conclusion that all will be fine? Soon, of course.

3. Extrapolation Bias

This is a mix of the so-called recency bias, also known as availability heuristic, and confirmation bias. A lot of market predictors make assumptions based on historic events, especially the most recent ones, which then serve to confirm, in their mind, that the same thing will happen again.

In the crypto community, the historical January dip was used to ‘confirm’ that everything would return to normal by late January or mid February. Except it didn’t.

4. Probability Neglect

When it comes to risk, which, for individual investors, can be seen as potentially losing all one’s money, we tend to react only to the magnitude of such an event, not its likelihood.

Let’s say you’ve invested into 20 coins. For your portfolio to go to zero, two things would have to happen:

All the companies behind those coins go bust. Traders abandon the coins, all speculating stops.

The chance of both of these events happening at the same time is very low, but because the outcome feels severe, we brush that aside and focus on the feeling. The same holds true for the opposite, where an overall market bull run might greatly increase your full portfolio, so you’re happy to believe it’s likely to happen.

5. The Backfire Effect

This is the bigger brother of confirmation bias and it’s worse. Scientific names include belief perseverance and the continued influence effect. What it means is that if you’ve previously agreed with a statement (“the bulls are coming!”) and are then presented with contrary evidence soon thereafter, not only are you not reconsidering your point of view, you’re reinforcing it.

That’s why corrections in the news do more damage than good. We keep our opinions and solidify them, rather than updating our mental archive.

6. The Bandwagon Effect

Quoting from a recent article of mine:

“In 1848, famous circus clown and later presidential candidate Dan Rice had a brilliant idea to support his fellow politician Zachary Taylor in his campaign. He would take his bandwagon, ride around town, and play music, while Taylor sat on top, spreading his agenda. This move was so successful that not only did Taylor become president, but politicians soon fought over a chance to sit on Rice’s wagon and parade around town.”

This is where the term “to jump on the bandwagon” originates and it’s easy to see why we do it: being part of the group feels safe. If everyone at the table is saying “Bitcoin will go to $20k,” it causes less cognitive dissonance to nod and agree than it does to say “you know, I think we might be in a bear market for a while.”

7. Loss Aversion

The direct result of something called the endowment effect, loss aversion describes the condition that it hurts us more to lose something we have than gaining something we don’t would make us happy. There are no exact numbers here, but as an example, if you buy Bitcoin for $10,000, psychologically, it might immediately be worth $15,000 to you.

Once it goes to $8,000, rationality briefly checks in and asks: “Might it be a good idea to sell?” However, fear subconsciously responds: “No, to me it’s worth $15,000, and as long as I hold on to it, I haven’t lost anything.”

As a result, very few people go on to predict losses at large scale, even if they might rationally believe they’re more likely than gains in the near future.

Photo by Andre Francois on Unsplash

8. Sunk Cost Fallacy

Related to loss aversion, the sunk cost fallacy says we tend to escalate what maybe used to be a rational commitment to an irrational level, just to stay consistent in our behavior. Especially investors who have been part of a bull run before are likely to succumb to this. They held through the previous run, so now they’ll endure lots of emotional pain to not suffer the actual loss from selling in the red in order to once again partake in the next upswing.

While this might work out, there is no objective reason that it has to. Sometimes, an investment is at a dead end. Sometimes, even the biggest storm doesn’t lift your coin back up with it.

9. Parkinson’s Law of Triviality

Lastly, the law of triviality states that, in order to deal with the emotional discomfort that results from all the above, we tend to overly obsess about trivial matters. For example making bull market predictions, rather than improving our skills as investors.

Keep it crypto,

Nik