Remember last week?
An oriental wise man always used to ask the divinity in his prayers to be so kind as to spare him from living in an interesting era. As we are not wise, the divinity has not spared us and we are living in an interesting era. In any case, an era that forces us to take an interest in it.
I’ll start today by borrowing Camus’s strong start to ‘Create Dangerously’. He goes on to make a different point (!) but the way it resonated with me was on how much of our time we spend keeping up with the interestingness of our era, and how little time we take to think and reflect without distraction.
The topic of today is a mild hangover from last week, and was triggered by Elon Musk’s news that he is no longer accepting bitcoin for Tesla purchases, and the whole crypto market crashing with it (no, he didn’t read my article!). I’ve been thinking out loud for the week on what a good example this was of the recency bias in action. To be on the safe side of this topic, I decided to brush up on my behavioural biases, and share that with you.
Few of us would confidently classify as the wise man in the story. But it’s a worthy goal to become one. In my humble opinion, understanding ourselves and our behaviours is key to becoming the archetypal wise but grumpy old man who shares valuable life advice while yelling at kids to get off his lawn.
What did Elon do this time?
He won a NASA contract. He’s going to the moon. But also, he’s been casually chatting to his 54 million twitter followers about crypto. A short timeline of Elon’s exposure to bitcoin:
- Jan: Changed his twitter bio to #bitcoin
- Feb: Announced Tesla owns 1.5bn USD in BTC
- Mar: Announced he’d start accepting bitcoin as payment for Tesla.
- May: Changes his mind and announced the environmental impact of bitcoin is too high so he’ll stop accepting payments. This is where people started to freak out on the news and the market price fell by 22%.
But in fact, it wasn’t news. The environmental impact of Bitcoin and the articles cited by Elon, and yours truly, have been around for about months. He didn’t indicate that they would sell their holdings, merely HODL. He loves publicity stunts, as evidenced by his hilarious SNL show. And there are rumours that he is in murky legal waters on BTC-related financial reporting.
His tweet nevertheless captured the public’s imagination, and we are talking about a market where everyone from financial expert to high school student can take part and express their opinion with their wallets. (N.B.: Remember when Trump moved financial markets one awkward tweet at a time, and Kylie Jenner wiped out 1.3bn USD of value from Snapchat because she was bored of it).
In other news
In other news, 1,000 USD invested 6 months ago in Bitcoin is now 4,060 USD. This same week Goldman Sachs, Citi bank and JPMorgan announced and/or re-iterated their activity in crypto, the Federal reserve announced they may scale back stimulus and traditional markets were also having a bad day.
I’m not saying this as a bull case for bitcoin, but what strikes me the most is how the Bitcoin narrative revolves so much around a few people, and how the most recent news that we hear persist in our mind so much more vividly.
Robert Schiller, a Nobel laureate in economics starts his latest book on Narrative Economics with the story of Bitcoin, and how more people became fascinated with the nerds-to-riches narrative. He argues that stories that become viral are those representative of an underlying trend and they way they are told can impact economic outcomes. Looking at individual stories through the prism of the broader story arc is helpful in creating much needed context to tweets and news clippings.
An un-biased approach to biases
The definition of insanity is doing the same thing again and expecting a different result. And somehow, we all do that every day by making seemingly irrational choices with a high degree of predictability. My susceptibility to a certain bias might be slightly different than yours, but rest assured we’re both at risk. The list is long, but the below are most at play this week:
Recency bias
Simply put, we put more weight on the information that we have received most recently. The last tweet and its price action is more important than the last 6 months, even when your intention is to hold long term. Morningstar explains this and how to avoid it with stock market crash examples.
Availability bias
The availability heuristic describes our tendency to use information that comes to mind quickly and easily when making decisions about the future. We prioritize memorability and nearness over accuracy. Elon Musk’s tweet is entertaining. That 30 page report from a reputable source is a bit less so.
Affect bias
Affect bias is strongest when we need to make a decision quickly. We rely on our emotions instead of rationality. Someone tweets, the market is tanking, our positions are being liquidated, and we need to make a call right now on our trading strategy. Our fear will govern our rational decision making. It is as difficult to control as it is obvious.
A good summary of cognitive and emotional biases is presented by Investopedia, as well as the CFA institute and the Decision Lab.
The godfather of behavioural science, Khaneman’s Thinking Fast and Slow (summary here, but I recommend the full book) lays the foundation of behavioural biases in a must-read book. Dan Ariely follows in his footsteps with two insightful books of biases, both generally in life and specifically with our finances. A superficial but thorough review of biases can be found in the Art of Thinking clearly.
For a cutting edge update, MIT offers a free eDX course on the topic of biases in financial markets.
Reading fast and slow
As with any good behavioural bias book, I’ll try to move past pointing out the problem and suggest some ways to address it.
Get informed about behavioural biases: Read about the topic, understand what you’re doing without even realizing. The more you read about it, the more you’ll be able to warn yourself of the biases as you’re living them.
Get your news from balanced sources: This rings true regardless of the topic. Specifically in the world of crypto, my favourite balanced views are Coindesk, The Block and Finmize.
Don’t read the news every day: Focus on slow, more long term reports which incorporate but do not overweigh news (e.g. Coingecko’s Q1 2021 Crypto report or industry perspectives reports on individual exchanges’ )
Remember last week?
Under a constant stream of new information, we need to be careful that we remember more than the last 3 seconds, today’s news, or yesterday’s and take a look at long-term secular trends.
The crypto market uses the term FUD (Fear Uncertainty and Doubt) to characterize the short term panic waves that make the crypto market tremble.
Make sure not to tremble on 140 characters or less.
Disclaimer: I am not your financial advisor (sorry not sorry, you’re better off as I’m still learning!) and I have skin in the game in the market.
