Still Struggling to Understand the Wisdom of Crowds

Recently TechCrunch offered a not-so-positive review of a new service called Piqqem that seeks to harness the wisdom of crowds:

Can Piqqem Use The Crowd To Pick Stocks? Don’t Bet On It.

Judging by the history of posts on this blog, this would be the point at which I decry Piqqem for failing to understand the factors that contribute to the wisdom of crowds. But, in fact, this time the service gets it: it asks users to predict stock futures, and they can't see other peoples' predictions until theirs are already in. Thus the service protects against the herding instinct that makes you (and me) more likely to favor a stock if we see that other people expect it to go up in price (otherwise known as the cumulative advantage).

Instead, this time it's TechCrunch that gets it wrong:

"If nothing else, Piqqem is certainly a good place to get ideas for stocks to invest in. But does it really have any chance of ever beating the market? Like any social investing site, its picks are only as good as the people who contribute to it. But beyond that, there is fatal flaw to this approach.

When it comes to stocks, the best prediction market out there is the stock market itself. It is the biggest prediction market out there, with millions of people predicting the future price of stocks every time they buy or sell shares. All of those predictions are aggregated together in the form of the price. To think that a few thousand, or even a few hundred thousand, people on Piqqem can do better is naive. And in fact, if you look at the prediction lines on Piqqem they already closely hue the actual stock price."

Where to start? The errors in this passage are almost too numerous to count:

1. "The picks are only as good as the people who contribute to it." Actually not true at all -- and that's why it's the wisdom of a crowd, not the wisdom of a crowd of experts. If you really want to know how this works, read the book, but here's the short version: experts tend to make incorrect predictions because they're deeply entrenched in accepted ways of looking at a problem. That's why an aggregate of amateurs can make predictions that are actually better; as individuals they know nothing, but when you average their individual errors, you end up with an accurate consensus.
2. The author (Erick Schoenfeld) conflates prediction markets with the wisdom of crowds. The book does talk about prediction markets, but it's not the same thing, for one primary reason: investors in a market are strongly influenced by what they see around them (which is where "irrational exuberance" and stock market crashes come from).
   
3. Schoenfeld cites the fact that Piqqem's predictions are holding close to actual market performance as a criticism of the service -- but isn't that exactly what Piqqem is trying to do? If Piqqem's predictions are perfectly accurate, a historical graph of its predictions will exactly match the market's performance; it will simply predict that performance a little in advance.
   

Bottom line: Schoenfeld clearly has not read (or, possibly, understood) the book, and doesn't really get the idea behind Piqqem. Take his criticism with a grain of salt.

Have Your Cake and Eat It?

Via Webware, I heard about Cake, a company that seeks to crowdsource stock trading:

Cake CEO Steve Carpenter believes that of the approximately $100 billion that consumers pay for stock management services, "a lot is wasted." He's built a service that identifies the stock picks from the best performing members in his community, and lets other users take advantage of their investing skills. Importantly, Cake doesn't show you just which stocks have done well among its users. That's old information. Rather, Cake identifies the users that are doing well in their portfolios and highlights their transactions, as they happen, for other users. One of the byproducts of that is the Cake Take, a rating service "akin to Morningstar," Carpenter says. But it's more predictive, more timely, and a lot less expensive to run, since it's algorithmic and not based on the opinion of paid analysts.

While the idea of cutting out the brokers and just letting the wisdom of the crowd guide you in your stock purchases does have a lot of appeal, this scenario raises certain issues:

• This is not a true application of the wisdom of the crowds, as defined in the book of the same name. As I've railed in this blog before, the wisdom of the crowds emerges only under certain conditions: it must involve a large number of people voting on a topic about which they are not highly educated/indoctrinated in a conventional way of looking at things, and they should have no contact with one another in doing so (to prevent them from exerting influence on one another -- the crowd can only be wise when it is composed of individuals, rather than members of a group). Cake's setup encourages you to follow a few highly-successful traders (rather than a whole crowd of them), and there is no reason to think those traders aren't watching each other and following the same leads.
  
• The whole enterprise is based on one article of faith: that top traders know what they're doing. It seems to me equally likely -- more likely, actually -- that these guys on top just happen to be on a lucky streak, and there's no more "wisdom" to be gained than you'd get by going to Vegas and asking some random old lady for tips on how to play the slots. (The proof is in the pudding: track the "top traders" on Cake over time, a year or more. If the same guys stay on top, they know what they're doing. If they come and go, it's all just another form of gambling.)

In short, it's not a crowd, and it's not likely to be wise.

Too often on Wall Street, it's the suckers who show up late who supply the money that allows the guys who got in early to cash out before the whole thing collapses. I don't doubt that Cake is entirely sincere in its crowdsourcing efforts, but I suspect that their product is likely to appeal to suckers destined to arrive when the party is over.

News Flash: Crowds Are Not Always Wise

There's been some hand-wringing this morning over the much-touted "wisdom of crowds":

When the 'wisdom of crowds' turns on itself: IMDB edition

I'm not going to quibble with the basic premise of the piece. "The Godfather" is most likely a superior movie to "The Dark Knight," though each film will have their proponents and detractors. What irritates me is the claim that the wisdom of crowds somehow broke down here. I've been seeing this a lot lately, and most of these pronouncements seem to be coming from people who don't know what the phrase properly means.

"The wisdom of crowds" isn't just a modern buzz-phrase, it's also a book that's well worth reading.


Go ahead and read it now. I'll wait.

Back already? Great. Now you've read the book and you know what the phrase properly means. You know that it doesn't imply that every time you get a large number of people together, they will inevitably and magically arrive at the correct solution to a problem. Crowds are not wise in that fashion, nor have they ever been so wise; if that were the case, then the best available candidate would be elected to office in every single election -- national, state, or local -- throughout this great country. In fact, crowds make mistakes quite often, which is why we have the term "mob" to refer to those moments when collective crowd judgment is at its worst.

Now that you've read the book, you know that a crowd is "wise" only under specific conditions:

1. First, it is a crowd of non-experts. Experts are too likely to think alike on a topic, and so collectively are unlikely to find the unexpected solution.


2. Second, it is a crowd of people who are not in contact with each other. People in contact discuss things and arrive at common conclusions. In the process they cease to be a crowd and become more like a mob. Only a failure to communicate ensures that they will act independently, which is essential to the aggregate of their collective actions showing the wisdom of crowds.


3. Third, it is a crowd of people who have something at stake. People voting on a trivial topic act erratically. They need to have some skin in the game: a prize they're hoping to win, or a valuable that they're afraid of losing, otherwise their actions are less likely to be meaningful.

So let's go back to the example at hand: people voting up "The Dark Knight" and voting down "The Godfather." Does anyone believe that these are the actions of a multitude of individuals acting alone? Far from it -- no doubt there are any number of internet demagogues rallying the troops and sending them off to the IMDB to stuff the ballot on one side or the other. Do they have enough at stake to ensure they are not acting at random? They do not. In short, this crowd cannot be wise because it is not a crowd, it is a mob.

Not that this is necessarily a bad thing. There's nothing like controversy to whip people up and get them online. Mobs that are actively engaged with your community site can be better than well-ordered crowds that only occasionally show up in your traffic logs. Unless, of course, your site is built around the expectation that collective action will produce valuable insight into a topic, in which case you should go back, re-read the book, and build a site that caters to the crowd rather than the mob.