Why it’s usually crazier than you expect

https://www.collaborativefund.com/blog/crazy/

by antdke • 5 years ago

166 154 5 years ago

tradri6• 5 years ago

Interesting read about feedback loops and self-fulfilling prophecies.

However, the author made it sound as if "momentum" is the only thing that drives human behavior. While it's certainly a part, I wouldn't say it's the only force driving human decisions.

tradri6• 5 years ago

To link it to the world of investing, other key factors that drive returns/risk of assets are value, size, quality, yield and volatility, besides momentum. It's a multi-variate equation.

cactus2093• 5 years ago

I don't think the author was claiming it's the only force. But I do agree this was interesting but felt like something was missing. If feedback loops are so powerful, why are most things actually fairly stable? How and when and why does something get sucked into a positive feedback loop? I'd be curious to read more thoughts about that.

tradri6• 5 years ago

isn't that the question of what makes things go viral?

PartiallyTyped2• 5 years ago

You may be interested in Douglas Hofstadter's Gödel Etcher Bach, or if you are into something shorter, 'I am a strange loop', by the same author.

tradri6• 5 years ago

Thanks for the suggestions. They seem interesting.

MaxBarraclough• 5 years ago

As the number of elephants declines, tusks become rare. Rarity pushes prices up. High prices make hunters excited about how much money they can make if they find an elephant. So they work overtime. Then fewer elephants remain, tusk prices rise even more, more hunters catch on, they work triple-time, on and on until the number of hunters explodes as everyone chases the last herd of elephants

This is almost the opposite of Jevon's Paradox:

the Jevons paradox occurs when technological progress or government policy increases the efficiency with which a resource is used (reducing the amount necessary for any one use), but the rate of consumption of that resource rises due to increasing demand.

https://en.wikipedia.org/wiki/Jevons_paradox

pimlottc• 5 years ago

Jevon’s paradox can also lead to virtuous cycles. For example, electric-assist bikes require less user energy per mile, making biking easier, which leads to more time spent biking, resulting in more overall exercise. Similarly, increased transit use can lead to more time spent walking.

laurent922• 5 years ago

There is also the vicious version: Mandating the wearing of helmets for cyclists increases the number of deaths, because of obesity and cardiac diseases due to raising the barrier to cycling.

chii7• 5 years ago

the number of hunters explodes as everyone chases the last herd of elephant

but the hunter that figure out how to farm elephants will be even richer. So the problem becomes one of technological breakthru coming first, or extinction coming first.

newbie578• 5 years ago

Wow, a really interesting read, nice to think about.

sound1• 5 years ago

Agree. I thought about how how my personal image perceived by others may affect my success or failure in life or career. Interesting and scary at the same time.

alex_young3• 5 years ago

Seems like another way to read this is to say that unchecked capitalism leads to some pretty unhealthy behaviors.

If people weren’t trying to get rich selling tusks we would have more elephants and if people weren’t trying to get rich with GME stock we would have less fear of our other investments being randomly targeted.

tradri6• 5 years ago

taking the anarchist's approach: if people are happier owning tusks and using the stock market as a casino than seeing elephants and having stable finances, let em do it.

alex_young3• 5 years ago

Do anarchists really believe that the profit motives of the few outweigh the collective interest of the masses?

danShumway2• 5 years ago

than seeing elephants

I don't want to strawman anyone. Are there really Anachrocapitalists who believe that the market should decide whether or not we have mass extinctions, or is this post mostly satirical?

There are so many problems with this idea, not the least being that markets aren't designed to eliminate niche ideas, they're designed to support them -- and because wild populations of elephants are a shared common resource, even a small number of people who are happier owning tusks means that their preferences suddenly outweigh the vast majority that want them to stop killing elephants.

Markets aren't designed to stop people from irreparably damaging commons and messing up the world for everyone. That doesn't mean markets are bad, it just means... that's not what they were ever designed to do. You're using them to try and fix a problem that they're not optimized to fix.

This is very much a, "if all you have is a hammer, everything looks like a nail" proposal. We don't need to solve literally every single problem with Capitalism. We especially shouldn't look at every single problem and say, "Capitalism doesn't solve that, so it's not a real problem."

throwawayboise• 5 years ago

If people could not become rich by profiting from their efforts, we'd all still be living in teepees and spending our days foraging.

alex_young3• 5 years ago

My criticism of unchecked capitalism isn’t the same thing as opposition to capitalism itself. In fact it’s easy to argue that capitalism cannot function without the limits we place upon it.

nradov• 5 years ago

In general there's no valid reason to fear our investments being randomly targeted. GME short sellers have only themselves to blame by pushing the total short interest to unsustainable levels and failing to hedge. That is a rare situation which hardly impacts any of us.

yibg• 5 years ago

Seems like a potential confirmation bias here with regards to GME. GME may be in a feedback loop right now, but how many other stocks had the beginnings of a feedback loop but fizzled out? How many companies started to win but didn't attract the best employees?

Put it another way, is there any predictive power here or is it only something that can be observed after the fact? Seems like the latter.

didibus• 5 years ago

There are firms I've heard of who have social media watchers and they play based on "buzz". I don't know how that pans out in long term holdings, but short term I'm guessing they've been successful or they wouldn't keep doing it.

PartiallyTyped2• 5 years ago

There was a post on wsb where he wrote a bot to keep track of sentiment around tickers. Then he played said tickers based on sentiment and the portfolio was consistent and possibly out performed the market but don't quote me on the last one.

JW_00000• 5 years ago

Also, are we even "after the fact" at this moment? In other words, let's see in three months' time (or one year) whether there really was a positive feedback loop that saved GME or whether there was a rapid boom-and-bust cycle and GME is back to where it was last year (or even bankrupt). It's too early to draw conclusions while we're still in the middle of the frenzy.

yowlingcat• 5 years ago

It's too early to draw conclusions while we're still in the middle of the frenzy.

100%. We're certainly not yet after the fact.

TameAntelope• 5 years ago

An article last week referred to this as "reflexivity".

* Reflexivity is a theory that positive feedback loops between expectations and economic fundamentals can cause price trends that substantially and persistently deviate from equilibrium prices.

* Reflexivity’s primary proponent is George Soros, who credits it with much of his success as an investor.

* Soros believes that reflexivity contradicts most of mainstream economic theory.

https://www.investopedia.com/terms/r/reflexivity.asp has some additional info.

I wonder if there's a way to marry "efficient market hypothesis" with "reflexivity on the edges" somehow. Well outside my ballywick, in any event.

marcosdumay• 5 years ago

No, you can't marry the Efficient Market Hypothesis with any kind of inefficiency. Even less one that isn't compatible with a market settling into equilibrium.

The hypothesis is just false. Markets do seek efficiency, but not the way it states. But the Efficient Market Hypothesis leads to tractable mathematics, so people try to approximate the real world into it.

FabHK10• 5 years ago

I think Keynes captured the essence of reflexivity nicely in his beauty contest:

"It is not a case of choosing those [faces] that, to the best of one's judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees."

https://en.wikipedia.org/wiki/Keynesian_beauty_contest

TeMPOraL• 5 years ago

I've read the Investopedia article, but I struggle to see what's the big deal about it? Where's the conflict?

The best I could summarize it is that "reflexivity" postulates that economic equilibria are usually not stable, but metastable. That is, they can be easily pushed out of their stability regime, at which point the feedback loops will no longer balance, and the equilibrium will get re-established elsewhere (if at all).

That's the only thing I can see that requires some empirical justification. Other than that, the postulates seem to be basically "feedback loops 101", and the "mainstream economics" concepts, as I understand them, are built on the same principles too.

xapata2• 5 years ago

I don't think there's necessarily a contradiction between a weak form of the efficient market hypothesis and the quite evident phenomena of reflexivity. Inefficiencies form, the agents seek them out and in so doing remove them. The question is how fast the inefficiencies are removed and how costly they are to discover. There's decent evidence that the inefficiencies can take quite some time to disappear. The tougher question is how costly they are to discover and exploit. Unfortunately, it's hard to gather evidence on that, because of the confounding variables (trade secrets and competition, selection bias).

Another way to put it: You might be the best poker player at the table, but you might not be enough better to beat the rake. Or, sure, you can count cards and win at blackjack, but the casino ensures through table limits that on average they'll still come out ahead. Card counters will spend too much money finding a table with a good count that they won't win enough back exploiting the count to make up for the cost of information. On average.

paulpauper4• 5 years ago

This did not work between 2000-2003. Companies whose share prices went up 10x still want away.

The GME rally amazingly even exceeds the biggest bubbles of 1997-2000 in %-change and volume.

paulpauper4• 5 years ago

It is very easy to reconcile it with the EMH and risk neutral pricing. If positive reflexivity exists, then presumably so does negative reflexivity, so it cancels out.

edouard-harris• 5 years ago

I wonder if there's a way to marry "efficient market hypothesis" with "reflexivity on the edges" somehow.

The key to this synthesis is that there is sometimes genuine, fundamental value to be had in creating a Schelling point for a resource or a certain kind of transaction. This is (part of) why online marketplaces are valuable and defensible businesses, for example.

"Reflexivity" is simply what it looks like when a Schelling point is in the process of forming. There are some very rare but very real cases in which a bubble really does create its own reality, and that reality sticks around because a shared delusion turns out to create enough real value to justify its existence. There is an art to identifying those cases, and that art is as well-compensated as one might imagine. (Most of the time, though, a Ponzi is just a Ponzi.)

mslate• 5 years ago

Isn't Collaborative Fund the one that got smeared by the CEO of one of its portfolio companies?

Previously: https://news.ycombinator.com/item?id=24793170

vladmk• 5 years ago

It usually is crazier than you expect but I feel the authors answer “small trends” is a cop out answer. Small trends can be found in any success, the contrarian view is more interesting: why do things go right when they’re not supposed to? “Small trends” is a bad answer for GameStop, the answer is more complex and the variables aren’t covered in this article

netsharc• 5 years ago

It seems like cheap thought but he tries to present it like it's deep insight.

And in 2008/09, people probably didn't want to buy from a bankrupt GM because it's hard to get spare parts from bankrupt car manufacturers. At least for the common definition of bankrupt (i.e. shuttered).

gautamcgoel• 5 years ago

The ideas discussed in his post, especially the idea of rapidly expanding spheres of civilizations consuming all resources in their path, were beautifully explored in Stephen Baxter's sci-fi book, Manifold: Space (a spin-off of his earlier book, Manifold: Time, which is also excellent). In his book, alien intelligences are common; once they become sufficiently advanced, their civilizations tend to rapidly expand and consume all available resources, often to the detriment of other civilizations in their path. This pattern leads to some interesting phenomena: first, while the night sky might seem quiet at first, once we do encounter aliens, we tend to see their signals across many star systems in rapid succession. The reason is pretty obvious: there is only a brief period of time when we are on the surface of a sphere - a few years after our first observations of aliens, we are engulfed within their sphere and observe their signals from all over our stellar neighborhood. Another idea he plays with is the idea of "refugee" species, who attempt to flee oncoming spheres by evacuating ahead of their path instead of being consumed.

Actually, he pushes this idea even further: in the book, our solar system was already engulfed in a few spheres millions of years ago. He suggests that this why Venus is such a hellscape: the aliens came, took the resources they wanted, and left behind a polluted mess. In the case of Venus, they left lots of greenhouse gases behind as the result of some chemical process used to extract resources; as a result, Venus quickly became the warmest planet in the solar system. It's a fun twist on the Fermi paradox: signs of aliens are actually all around us, we are just too dumb to notice them.

Another interesting idea he explores a bit is "ownership" of resources. Do the resource-rich asteroids in our solar system really belong to us? Or are they available to any alien race who happens to pass through? In the book, we first notice aliens by observing unexplainable infrared radiation from the asteroid belt (later revealed to be thermal emissions from their resource extraction). He suggests that these aliens will potentially crowd out humans; even if they are not overtly hostile, they could gobble up all the resources we would have used to expand our civilization.

Highly recommend this book.

abbadadda• 5 years ago

Where does one buy said book, "Manifold: Space"? I'd prefer paperback or hardcover (no options on UK Amazon)... sounds very interesting.

jfk13• 5 years ago

eBay? https://www.ebay.co.uk/sch/i.html?_from=R40&_trksid=p2380057...

AndrewDucker• 5 years ago

https://smile.amazon.co.uk/dp/0008134472/ref=cm_sw_r_cp_apa_...

kqr2• 5 years ago

https://www.amazon.co.uk/Space-Manifold-Trilogy-Book-2/dp/00...

superzamp• 5 years ago

Had to read this twice, I think you meant to comment on this thread: https://news.ycombinator.com/item?id=25972111

chii7• 5 years ago

The same sort of ideas are explored in the "three body problem" trilogy (https://en.wikipedia.org/wiki/The_Three-Body_Problem_(novel) ). I love fiction that explore this topic!

FabHK10• 5 years ago

1. I was expecting to read about a gamma squeeze... (people buy far out-of-the-money calls on GME (low delta), option seller is short, buys a bit of GME to get flat, more people buy & price goes up, delta goes up, option seller needs to buy more stock to hedge, and you have your feedback loop going (until option is far in-the-money, delta is one, and option seller doesn't need to buy anymore).)

But that never came... it was just positive feedback in perception.

2. It's not "usually" crazier than you expect. Most everywhere, we have feedback loops that keep things stable. Demand rises, prices rise, people think, eh, too expensive, and demand and supply are in balance again. Airplane gets bumped nose-up a bit, angle of attack increases on the wing and the horizontal stabiliser creating upward forces, but everything (centre of gravity, tail volume, etc.) is carefully designed such that this results in a nose-down momentum until the plane is in equilibrium again. And I could go on.

That's why it is so unusual when things spin out of control (nuclear bomb, anyone?).

3. As for GME, I trust that the forces of the market will pull it back down where it belongs soon enough.

EDIT: closed parenthesis

xapata2• 5 years ago

Using the airplane analogy, there's a good amount of turbulence in the market. Especially as you look at smaller scales, both in time and price changes. There's a decent amount of literature discussing evidence that low-latency trading has increased market turbulence for little efficiency gain.

I'm having trouble scrounging up links, but a lot of good research came out of the Santa Fe Institute and associated folks.

FabHK10• 5 years ago

Absolutely... I think HFT is useless rent seeking. It provides little efficiency, I think, and the liquidity often drops out when the market needs it most, anyway.

sillysaurusx2• 5 years ago

Anyone want to ELI5 gamma squeeze? Isn’t that just a description of what happened with GameStop? But then I thought that was a short squeeze.

joncrane• 5 years ago

Gamma squeeze has to do with options, short squeeze has to do with just stock.

Therefore the gamma squeeze has a timing component, while short squeeze can happen at any time irrespective of when options expire.

FabHK10• 5 years ago

Let's give it a shot.

Squeezing shorts is trying to make sure that the shorts (that need to buy back shares) don't find any shares to buy, thus driving up the price (as they'll offer more and more to buy the shares they're obliged to return to those they borrowed them from).

With a gamma squeeze, you also aim to drive up the price, but the mechanism is a different.

As you might know, the payoff of a call option (as a function of the stock price S at expiry) looks something like this:

__/

With S below the strike K, it's worth nothing, and as S exceeds the strike, the payoff goes up.

The price of a call option before expiry looks basically similar, but smoothed out.

The delta of an option is the first derivative of that graph, or, to put it differently, the change in the price of the option as S goes up. You can convince yourself that when S is very low, the delta of the option is very close to zero, and as S approaches K, the delta increases, and with S much higher than K, delta is basically 1.

(Take an option struck at 50. When S = 10, it's worth basically nothing, and when S = 11, it's still worth basically nothing. So, delta = 0. When S = 200, option is worth about 150, when S = 201, it's worth about 151. So, delta = 1.)

[Gamma is the second derivative. It's basically zero when the stock price is very low or very high, as delta doesn't change. But near K, gamma rises - delta changes!]

Now, if an option trader sells you a call, you're long (you win if the stock goes up), trader is short. Trader doesn't like that risk, so they'll buy the stock to cancel out their price risk. How much stock? Well, depends on delta. If S is small, and delta, say, 0.1, they only need to buy 0.1 stock. Then, for small movements of S (say, a small increase), what they lose on the option, they gain on the stock.

However! If the stock moves substantially, particularly if S approaches K, the delta of the option goes up (gamma is not zero anymore). So, the trader needs to buy more shares to be flat again.

So, here's the strategy: Cheaply buy way-out-of-the-money call options (S << K). Then, manage (somehow), to drive the share price S up towards K. The trader who sold you the options will then buy S, potentially driving up S even further. That's the gamma squeeze.

[Note: The trader that sold you the call charged you a fixed premium at the beginning. Now they must buy the stock when it has gone up, and sell it when it has gone down. So, as the share price goes up and down, they lose money (since they buy expensive and sell cheap). If the share price goes up and down a lot, they'll lose more than they got on the premium. If the share price goes up and down only a bit, say when it moves smoothly in one direction only, or not at all much, then they'll lose less than they got on the premium, so they'll win.

That's why we say that someone that wrote a call is short realised vol: if realised vol is high (higher than the implied one that he charged you for the option), they'll lose, and vv.]

When you wrote an option, you're short vol, short gamma, and long theta. When you bought an option, you're long vol, long gamma, short theta.

e79• 5 years ago

Re #3: I held off investing significant money into Bitcoin because I was convinced that the forces of the market would pull it back down to $10 where it belonged soon enough. I’ve been asking myself ever since why I felt so sure at the time.

As for GME, there’s fundamental analysis and financial experts telling us it is only a matter of time before the price free falls. But there’s a serious behavioral dissymmetry here. The market is rich with GME stock buyers who don’t care to listen to any of these traditional buy/sell signals. I’m not sure you’re wrong, but I’m personally a little bit less certain that the price will drop — at least soon — due to this reason alone. As this article points out, feedback loops can be extremely powerful. And I suspect they can play out over longer periods than we expect.

cccc4all5• 5 years ago

The GME situation is huge mess created by billionaire vulture short sellers shorting more than 100% of stocks. Thereby, when you buy current GME stock, the stock also has an attached buyer that has to buy that stock back, at ANY price. All you have to do is simply buy and hold the stock, and the price will go up.

Traditional buy/sell signals are irrelevant, because of the short seller shenanigans. The short sellers created this perfect trap for themselves, now they are scrambling to get out of using every dirty tricks. The more WSB crowd is aware of this scenario, the more they jump in to the diamond hands philosophy.

FabHK10• 5 years ago

Your investment thesis would then be that GME becomes a token of value independent of the underlying business, dividends, and so on. More of a collector's item.

Intriguing, and (lamentably) not entirely impossible. But, you know: bubbles do have the habit of bursting.

nostrademons• 5 years ago

Bitcoin did end up dropping about 80% from its late-2017 high. It took about 10 months, but it bottomed out in the 3000s, down from $17K in Dec 2017.

Wouldn't surprise me if GME does the same thing - just the sheer number of shorts will blunt the price declines a bit, as they cover.

newacct583• 5 years ago

The market is rich with GME stock buyers who don’t care to listen to any of these traditional buy/sell signals.

It is this week. But let's be honest: (1) wallstreetbets isn't a very large community compared with the whole market, or even the capitalization of GME or AMC and (2) these are investors engaged in a fun revolution.

This won't stay fun for months. These folks want to trade in those portfolios. And if this doesn't go up any farther (it's been flat at ~$300 since Thursday), how many of those will get bored and sell so they can trade whatever the next meme stock is? Not that many, sure. But enough to push the value down lower, to a threshold where more Robinhood traders decide to get out. And we have exactly the kind of feedback loop described in the linked article.

GME is going to fall because there's no reason for GME to stay high. Once the short squeeze is over and the lols play out, it's just another failing company.

(And I continue to believe that this is going to turn out to be a big astroturfed scam when this is all said and done and I'm betting a bunch of the early players will turn out to have been executing a pump and dump.)

AmericanChopper• 5 years ago

GME stock will undoubtedly be carried for some period of time after the squeeze is over (is it already over? I don’t know...) by momentum and hype. But the inevitable outcome is that it crashes, because GameStop fundamentals are simply bad.

Bitcoin is a completely different proposition however, because so much of the demand is driven by black market commerce, and other equally inscrutable factors. Both the supply of and demand for Bitcoin are completely volatile. There’s basically no hope of performing a reasonable analysis of where it’s value might be heading.

dreamcompiler3• 5 years ago

Bitcoin is not a stock and has no fundamentals; GME does. There's no objective value metric for Bitcoin so it can float freely. But because GME is at least loosely tethered to the value of a real company, I'm confident that will bring the price back to reality.

cccc4all5• 5 years ago

Time in the market is more important than timing the market, is a common investment advice.

Current GME situation is not investing, it's short term speculation and gambling and ideological tussle and class fragmentation thrown in. All investing strategies and tactics are thrown out the window.

The billionaire vulture short sellers got careless and lazy by shorting 140% of stock. Then, they got caught with their pants down with naked shorts and now squealing to everyone to bail them out. They could have just ate the losses, but they decided to pull all the dirty tricks and shenanigans. It may or may not work.

The WSB crowd battling the billionaire vulture short sellers are out for more than gains.

gruez3• 5 years ago

but they decided to pull all the dirty tricks and shenanigans

like what?

The WSB crowd battling the billionaire vulture short sellers are out for more than gains.

I'm personally skeptical of this. It's easy to say you're doing this with noble reasons on the way up, but it's hard to tell whether the people are serious, or they they're trying to ensure there's enough bagholders to sell into.

paulpauper4• 5 years ago

It would seem almost all the GME buying is in the afterhours and premarket, causing these huge 100% gaps. This suggests an effort to squeeze call sellers, as options cannot be traded afterhours and rpemarket. This means call sellers need to buy stock to neutralize the delta.

ineedasername• 5 years ago

EDIT: closed parenthesis

Well, it still failed to compile because you didn't have a trailing ";" and the rest of your comment wasn't even in programming code.

einpoklum• 5 years ago

Title should say what "It" is.

paulpauper4• 5 years ago

It’s simple: As the number of elephants declines, tusks become rare. Rarity pushes prices up. High prices make hunters excited about how much money they can make if they find an elephant. So they work overtime. Then fewer elephants remain, tusk prices rise even more, more hunters catch on, they work triple-time, on and on until the number of hunters explodes as everyone chases the last herd of elephants whose super-rare tusks are suddenly worth a fortune.

Or maybe simply selling tusks is profitable and there does not need to be a feedback loop for elephants to go extinct.

chii7• 5 years ago

Or maybe simply selling tusks is profitable and there does not need to be a feedback loop for elephants to go extinct.

but that's not logical, because if selling tusks is profitable, then more people will want to join in, thus increasing the number of tusks being sold (implying more elephants being killed for it). Until profit goes away due to drop of demand at least.

m3kw92• 5 years ago

There seem to be survivorship bias and the examples he demonstrated are probably at the tail end of a distribution

CamelCaseName• 5 years ago

Has anyone seen surprising feedback loops they can share?

m3kw92• 5 years ago

Question: Is it possible foreign actors can drive up the price to try to cause adverse unintended effects?

dreamcompiler3• 5 years ago

This article is solely about positive feedback loops (even though the author never says "positive.") If positive feedback loops were the whole story every stock that rose a little would take off like a rocket. Clearly that doesn't happen, and it's because there are also negative feedback loops, like noticing that a stock is overvalued and refusing to buy it until the price comes down.

What makes the future difficult to predict is that negative feedback loops and positive feedback loops are often fighting each other and you never know early on which will ultimately dominate.

zyngaro• 5 years ago

There’s a name for that: the snowball effect

Why it’s usually crazier than you expect

Related Stories