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Friday 11 July 2014

S is for Self-Enhancing Transmission Bias

Self-Enhancing Transmission Bias is what everyone does when they talk about themselves: they big themselves up and conveniently forget about their mistakes. And as everyone does this across a network you will get an amplification effect: everyone is great at investing and no one ever gets stuff wrong. And the more we broadcast, the greater the effect.

Example

A study of a Facebook like social network looked at what happened if investors transmitted details of their successes but not their failures. Unsurprisingly it turns out that the more successful an investor appears to be the more likely other investors are to copy them. And this effect leads to everyone trading more, and the more active investors are the more likely they are to lose money relative to the market. Of course, the successful investors may only be broadcasting their successes and not their failures, and this is especially likely over non face-to-face channels like social media and the internet.

Causes

Talking about how successful you are is a good way of maintaining your own self-image and of enhancing your reputation. Generally people prefer to present themselves in as positive a light as possible short of actually lying: but selective omission of information, like failing to mention the 50% of trades you made that went wrong, seems to be acceptable to most of us. In a social context most people who exaggerate their abilities will tend to be found out, but the more remote the social interaction the harder it is to detect.

There's a secondary effect as well, because if we are told the same thing from the same original source multiple times through different channels we fail to discount the fact it's the same information and give it more weight. So internet investors getting excited over a stock may be a sign something's afoot - but it may be that some idea has gone viral.

Mitigation

If you get your trading ideas by following people on the internet who tell you that they're great at investing you have only yourself to blame for your losses. Don't do it.

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