Stupidity and Trading

Seven Varieties of Stupidity
(and what to do about them)

Note: I wanted to post an article titled: “3 Secrets of Everlasting Victory in the Markets – Part 2” but I had to postpone it in favor of the article below. Trading is a 100% psychological game, and that is why many experienced, knowledgeable, and skilled traders still suffer huge losses in the markets, and some of them remain poor, despite many years of experience. Once given another opportunity, they will end up making the same mistakes again, owing to undisciplined psychology. You will see traders crying like babies after receiving margin calls, only to repeat the same mistakes that led to previous margin calls, when they resume trading again with fresh funds. The article below is for the populace, but it also has a lot to do with trading and investing. The truth in it can make a difference in your trading career.

“There are so many kinds of stupidity, and cleverness is one of the worst.” – Thomas Mann.

Many words have been expended on the nature of intelligence, while the topic of stupidity is comparatively neglected – even though it is all around us, screwing us up. That’s probably because we assume stupidity is just a lack of intelligence. I think there’s more to it than that. It comes in many different forms; what follows is by no means comprehensive.
1. Pure stupidity
Let’s start with the most obvious type of stupidity: shit-for-brains (excuse the scientific jargon). The common sense definition of a stupid person is someone deficient in cognitive ability, specifically the ability to think and reason clearly. A stupid person has a low IQ. They flunk verbal reasoning tests and Raven’s matrices because they find it hard to spot patterns in data, manipulate language, or follow chains of logic. (I’m bracketing the question of whether analytical reasoning is intelligence – if it is, then according to the Flynn effect our ancestors were all morons – but the lack of it is what most people mean by stupidity). Presented with anything complex, the stupid person sees only meaningless chaos. Introduce a stupid person to a game and they will fail to understand the rules, even after they have been explained clearly and repeatedly, because they cannot learn, or can learn only slowly. Intelligence is inseparable from learning, something that it took AI scientists a long time to figure out; they spent years trying to design an intelligent machine until they realised it’s better to build a dumb machine that learns fast.1 What are the causes of this kind of stupidity? Genetics? The person may have inherited bad mental hardware. Environment? Maybe they grew up in a culture that never required them to learn or think. Or maybe they were poisoned: a recent study found that lead has been responsible for the loss of almost a billion IQ points in post-war America. Whatever its cause, stupidity in this sense means the inability to identify patterns, follow logic, or learn from experience. A stupid person is a novice at everything all the time.

2. Ignorant stupidity
Ignorance is also a common sense definition of stupidity: stupid people are people who don’t know shit about shit (another scientific definition). Now, ignorance is by no means always a sign of stupidity; any intellectual exploration, including science, depends on being aware of what one doesn’t know. But it’s also true that people who can’t draw on a bank of experience, technique or knowledge will find it very hard to cope with new problems and tricky questions. How do they get that way? Perhaps they have faulty hardware, as per #1, and so have been unable to acquire and retain information, or it might be that they haven’t been given the chance to do so: maybe they didn’t get much of an education, either from their parents or from school, and so lack the basic tools and frameworks needed to make sense of the world – verbal and mathematical skill, a knowledge of basic geography or political systems and so on. The education scholar E.D. Hirsch has observed that the ability to read a newspaper and have even the vaguest idea of what all the articles are about requires a level of general knowledge most of us take for granted. Background knowledge in any domain is like water for fish: we’re barely aware we have it but it’s what enables us to absorb new information. The less you know, the harder it is to learn; the less you can learn, the less you know – the stupider you get. This is the ignorance loop, and people with perfectly good hardware can get stuck in it.
3. Fish-out-of-water stupidity
So far we’ve discussed common sense definitions of stupidity. It tends to be described as a lack of something – either cognitive horsepower (‘intelligence’), or knowledge, or thinking. This seems inadequate. Defining it only as an absence of brainpower fails to account for what I’m calling fish-out-of-water stupidity. People with powerful brains who have acquired a great deal of knowledge in one domain, and who are therefore regarded as exceptionally smart, tend to assume they will have exceptionally smart thoughts in every field of knowledge they wander into. They take their own accumulated knowledge for granted and believe that the facility it gives them in their field is merely a function of their all-round brilliance.

Now, to some extent, these experts are probably right to assume that because they’re smart at this thing they’ll be smart at other things too – there is such a phenomenon as general intelligence. But they can wildly over-rate how intelligent they are in new domains and end up making terrible decisions. Twitter has been great for revealing how scientists or historians can be stupid once outside of their academic field. Often, experts don’t even notice that they have moved into a foreign domain: the bankers who screwed up in the 2008 crash thought they were in the domain of risk when in reality they were in the domain of uncertainty. Regulators who were flat-footed during during the pandemic (more of a problem for the US than the UK) failed to clock that they were now in the domain of crisis management.

4. Rule-based stupidity
We often talk about stupidity as if it is an individual trait – something a person is or isn’t. It is commonplace to talk about smart people and stupid people, even among intellectuals: one of the few scholars to have taken stupidity seriously, at least somewhat, was the Italian economist Carlo Cipolla, who wrote an essay in 1976 called The Basic Laws of Human Stupidity which you can buy as a book. As you can see from this summary of it, Cipolla starts from the premise that the world divides into stupid and non-stupid people and builds his “laws” on top of it (‘Always and inevitably, everyone underestimates the number of stupid individuals in circulation’). The essay is wittily written but I suspect the reason it’s still being read is that it is comforting. It is nice to imagine that a person is either clever or stupid – and that since I realise that, I must be one of the clever ones. It is more unsettling to think of stupidity as something that anyone, even you, can be captured by.

Stupidity can be systemic. The Santa Fe Institute complexity theorist David Krakauer observes that the Romans, as intelligent as they were in many ways, made no advances in mathematics. He puts this down to a numeral system that made it virtually impossible to do complex sums. Arabic numbers, imported to Europe in the Middle Ages (not as dumb as their reputation), are easier to manipulate. The new system made our civilisation collectively smarter, or at least less dumb. The tool or platform we’re using can keep us stupid, even when we’re smart. In fact, Krakauer’s view is that stupidity isn’t the absence of intelligence or knowledge; it’s the persistent application of faulty algorithms (itself an Arabic concept, of course). Let’s say someone hands you a Rubik’s Cube.
Consider three possibilities. You might know an algorithm or set of algorithms which enables you to solve it quickly, and look very smart (actually Krakauer would say that is a kind of smartness). Or you might have learnt the wrong algorithms – algorithms which ensure that no matter how many times you try, you’ll never solve the puzzle. Or you might be completely ignorant and just go at it randomly. Krakauer’s point is that the ignorant cuber at least stands a chance of solving it accidentally (theoretically speaking – don’t try this at home) whereas the faulty-algorithm cuber never will. Ignorance is insufficient data to solve a problem efficiently; stupidity is using a rule where adding more data doesn’t improve your chances of getting it right – in fact, it makes it more likely you’ll get it wrong.

Look around and you can see people trapped in flawed algorithms (if there is war, then it must be America’s fault’; ‘if there is a market crash then a recovery is just around the corner’) Rules of thinking inflexibly applied lead to stupid conclusions. You find a lot of stupidity among people who are highly partisan on behalf of a political party or ideology. Those people tend to be cognitively inflexible, regardless of which side they’re on. They are drawn to clear stories or chains of reasoning. The politicians or activists who capture them are skilled at building and disseminating these algorithmic structures of thought.

Very often, stupidity isn’t derived from an absence of mental materials but from a superfluity of them. It is the product of all the stuff we carry around in our minds and absorb from others: powerful algorithms, bad theories, fake facts, seductive stories, leaky metaphors, misplaced intuitions. The stuff that feels like solid knowledge even though it isn’t. As the old saying goes, it’s not what you don’t know that will get you into trouble but what you do know that isn’t so.

5. Overthinking-stupidity
When the psychologist Philip Tetlock was a graduate student he witnessed an experiment, designed by his mentor Bob Rescorla, which pitted a group of Yale undergrads against a rat. The students were shown a T-maze, like the one below. Food would appear at either A or B. The students’ job was to predict where the food would appear next. The rat was set the same task.
Rats and Mazes
Rescorla applied a simple rule: food appeared on the left 60% of the time and on the right, 40%, at random. The students, assuming that some complex algorithm must be at work, looked for patterns and found them. They ended up getting it right 52% of the time – not much better than chance and considerably worse than the rat, which quickly figured out that one side yielded better results than the other and so headed to the left every time, achieving a 60% success rate.

Smart people, or at least people who have come to believe they are smart, dislike strategies that incorporate the inevitability of error. Confronted with what looks like randomness, they won’t throw up their hands and go with the flow. They wish to impose themselves on the world. That kind of intellectual ambition can lead to insight and innovation but it can also lead to stupidity, when errors are energetically and skilfully defended.

Once a clever person has adopted a mistaken belief it is very hard to talk them out of it: ‘cognitively sophisticated’ people are if anything more susceptible to flawed thinking than average, because they are so skilled at bending reality to fit the model of it they have constructed. I suspect this tendency is associated with high verbal fluency, a quality I used to admire unreservedly but now view with suspicion. People with the ability to speak brilliantly off-the-cuff are also likely to be very good at finding instant and persuasive justifications for whatever it suits them to believe at any point. The right words just magically appear, perfectly turned, glistening like truth.

You can observe another manifestation of overthinking every time you use a product or app that is so crammed with ingenious features it’s impossible to use, or watch a movie that has everything going on except a coherent story. Clever people have a tendency to add features to a product or movie or argument rather than subtract them, which can produce stupid outcomes.

I am particularly wary of cleverness when applied to social and political questions, which can’t be solved with maths. In this I’ve been influenced by some clever thinkers. You can trace a fundamental divide in Western thought between those who believe that knowledge and rationality invariably make us smarter and those who warn they can also make us dumber. On one side, Aristotle, Descartes, Kant, Voltaire, Paine, Russell; on the other, Socrates, Montaigne, Burke, Nietzsche, Freud, Wittgenstein. The latter group includes thinkers who are, in their different ways are interested in the ways that human intelligence generates a unique kind of stupidity. These are my guys.

6. Emergent stupidity
Quite often in organisations that do stupid things, it’s hard to pin the stupid decisions on any one person even in retrospect, and there may be no stupid individuals involved. Sometimes, as with Enron, the people are very smart. Stupidity can emerge in the same way that intelligence emerges in a flock of geese, or an ant colony, or the cells and synapses of the human brain. When a group of individuals are following a few simple rules in co-operation with each other, then collective behaviour which is much smarter – or much stupider – than the sum of its parts may emerge. In any organisation, leaders should reflect on the simple rules that people follow even when they’re not thinking, and ask if they’re more likely to generate intelligence or stupidity.

There is no innate human drive to avoid stupidity. We evolved to survive and thrive and that means getting along with others – that’s our priority, most of the time. The good news is that getting smarter and getting along are not necessarily at odds with one another; the bad news is that they often are. In my book CONFLICTED I show how avoiding open disagreement reduces the collective intelligence of any group. The more that members of a group follow a rule like ‘agree with the consensus’ or ‘agree with the leader’ the less gets contributed to the general pool of ideas and arguments. The shallower the pool, the more likely it is that something stupid will crawl out from it, covered in slime.
7. Ego-driven stupidity
We’ve talked about stupidity mainly as a cognitive phenomenon but of course it’s deeply bound up with emotion, and with the sense of self. We could probably name seven varieties under this heading alone but the basic principle is that the more insecure a person feels, the more willingly they will make themselves stupid. Psychologists call it ‘identity-protective cognition’. We might call it the ‘I’m with these guys’ effect.

There is a well-established correlation between the propensity to fall for conspiracy theories and feelings of anxiety, specifically the feeling of not being in control. You could see this in action after 2016 when the online left in the UK and US started feeding hungrily on conspiracy theories about Brexit and Trump. Lots of clever people felt helpless and scared and displaced and made themselves stupid in response.

Political extremists and conspiracy theorists crave the safety of clarity. It’s not just the ideology or conspiracy theory to which people are drawn, but the community that forms around it. The ideology or theory is like a park or stadium – it is social infrastructure. You like being there, and your beliefs are the wristband. If you’re worried about being thrown out you’ll do everything you can to show how loyal you are to these beliefs, and how little you care about the opinions of outsiders. Even if it means repeating and believing stupid things.

I wrote positively about Twitter last time so I think I’ve earned the right to say that it’s also a space where the forces of stupidity converge and dance. You have experts who feel compelled to pronounce on matters outside their expertise. You have insecurity and status anxiety: everyone jostling for followers, likes and retweets. You have people doing their thinking in public, in the gaze of peers and enemies. You have ideological communities and sub-cultures who are also up in each other’s faces all the time, in-groups gaining energy from out-groups. The result is that some quite stunningly stupid threads go viral and get celebrated by lots of smart people (you’ll have your own examples – this one is a doozy). But it’s also an interesting laboratory in which you can observe the process of someone struggling to manage and reconcile affiliations with different groups. People can have more than one identity to protect – a scientist may want to maintain a ‘good scientist’ identity with peers and a ‘good liberal’ identity with the public. It’s revealing to see which one they go with when a conflict between these identities arises. More often than not they choose unscientific stupidity (a recent example of this below the fold).

The truth is that stupidity is often an act of will: people make themselves stupid, when it suits them. That humans are able to do this at all is, in its way, quite impressive. The English psychoanalyst Wilfred Bion fought in the First World War, and his ideas were shaped in part by that experience. Bion was fascinated by the way that people shut down their capacity for thinking and reasoning when they go into battle, figuratively as well as literally. His theory of how people learn was unusual in that he incorporated the fact that we don’t always want to know. People don’t just miss out on knowledge; they unconsciously resist or reject it. They seek minus knowledge, which Bion called -K. Failing to learn from experience stems from fear of thinking about what we don’t know, and sticking to the reassuring heuristics and habits at hand. Learning from experience, according to Bion, requires the hard, uncomfortable work of thinking about our own emotions. Put it that way and you can see why many of us so often choose stupidity.

Author: Ian Leslie
Source: Seven Varieties of Stupidity