The Zollman Effect: On The Stupidity of Crowds
The little known “Zollman Effect” runs counter to the widely accepted notion of "the wisdom of crowds." In a nutshell, mirroring Marcus Aurelius (The opinion of 10,000 men is of no value if none of them know anything about the subject) it notes that there are often occasions (not least in the absence of insiders) when it is actually not beneficial for large groups of people to come together and to communicate with each other as regards making predictions about future outcomes. When there are no insiders (and therefore little to no hope of any price discovery process taking place - think political betting markets) large network connection groups typically display significant collective cognitive and social biases and they often succumb to motivated reasoning and a conformity bias, tending to coalesece quickly around a dominant prevailing narrative: in the process often refusing to entertain alternative counter-factual arguments,
to the point of even being unwilling to pass on good information to each other that goes against the collective grain. (Bitcoin/Wallstreetbets/Recent Global Bank Selloff).
People in these groups shed their individual perspective/outlook and this gives rise to a collective "unconsciousness" and a situation whereby each individual's behaviour becomes governed by the "group mind".
A worrying aspect of these group networks, is the degree and extent to which they can become influenced and manipulated by "pernicious influencers" - often leading media or industry figures - who, under the guise of offering up useful information, actually muddy the water, by simply passing on noise as though it were actually meaningfull information and thereby preventing the group from reaching a proper consensus based on all of the available evidence (think Mark Cuban/Elon Musk chatter over GameStop and "Dogecoin goes up over 40% after Elon Musk, Mark Cuban tweet about it or Michael Burry's recent tweet "It is possible today we found our Enron." ). At a more sinsiter level, you have characters on social media, who quickly build up large followings on the back of bombastic boasts that they have placed significantly large trades in bombed out penny stocks.
Whilst group consensus is difficult to shift, it is not immune to being shaken up in a rather dramatic fashion, such as where an individual pops up out of nowhere and takes a large position against the crowd's prevailing narrative - such as for example, when somebody spots that it is time to take profits in Tilray because the retail crowd have gotten carried away with themselves.).
or when, out of the blue, a major sell program upends the popular trade in heavily shorted biotech stocks. Or a digital bank run, when a sudden, social media inspired widespread cash withdrawal, among a group of depositors who share an industry and social ties, leads to things unravelling very quickly.
Bank Shares Tumble in Wake of Failures: New York Times.
In the end of the day it is all about how we go about processing information - not least, the way in which we choose to privilege certain pieces of information at the expense of others.
There is always a massive paradox at work. We are bombarded with other peoples opinions through social media channels and, one way and another, if we are to reach a decision, we must decide what it is that we are going to do with them. At what point, if ever, are we going to decide that it would be better for us to abrogate our own preconceptions? What exactly is it about our past experinces, our affect states, our emotions, moods, perceptions, thoughts, memories, beliefs, values, and personality traits that is leading us to believe the things that we believe and to act accordingly on them.
In nuce, Zollman argues that highly connected networks that do not contain true price discovery mechanisms quickly converge to uniform beliefs that are actually riddled with noise and held in place by chatter, whilst more sparse networks, in which each of the participants interrogate the evidence on their own terms and share their findings with each other (even when contradictory) have a better chance at filtering out the noise and accordingly getting closer to the underlying truth - think about the case of Nate Silver and 538
and political betting markets.
Hit with the double whammy of being prone to both biases and self-doubt, people seek comfort in the crowd. They succumb to herding and respond to information cascades and relish in the sense of belonging that comes from being part of a larger group; but danger, as Jung so succintly points out in the following quote, is always just around the corner: “No doubts can exist in the herd; the bigger the crowd the better the truth — and the greater the catastrophe.”
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To cite this article: Niall O'Connor
The Zollman Effect: On The Stupidity of Crowds. (Published on Bettingmarket.com 26/03/2023. All Rights Reserved.)