A video explaining Induction Bias by Rolf Dobelli the author of The Art of Thinking Clearly on the IDFC Mutual Fund Youtube Channel.
WHAT IS INDUCTION BIAS AND HOW TO RELIEVE PEOPLE OF THEIR MILLIONS
A farmer feeds a goose. At first, the shy animal is hesitant, wondering ‘What’s going on here? Why is he feeding me?’ This continues for a few more weeks until, eventually, the goose’s scepticism gives way. After a few months, the goose is sure that ‘The farmer has my best interests at heart.’ Each additional day’s feeding confirms this. Fully convinced of the man’s benevolence, the goose is amazed when he takes it out of its enclosure on Christmas Day – and slaughters it. The Christmas goose fell victim to inductive thinking, the inclination to draw universal certainties from individual observations. Philosopher David Hume used this allegory back in the eighteenth century to warn of its pitfalls. However, it’s not just geese that are susceptible to it.
An investor buys shares in stock X. The share price rockets, and at first he is wary. ‘Probably a bubble,’ he suspects. As the stock continues to rise, even after months, his apprehension turns into excitement: ‘This stock may never come down’ – especially since every day this is the case. After half a year, he invests his life savings in it, turning a blind eye to the huge cluster risk this poses. Later, the man will pay for his foolish investment. He has fallen hook, line and sinker for induction.
Inductive thinking doesn’t have to be a road to ruin, though. In fact, you can make a fortune with it by sending a few emails. Here’s how: put together two stock market forecasts – one predicting that prices will rise next month and one warning of a drop. Send the first email to 50,000 people, and the second email to a different set of 50,000. Suppose that after one month, the indices have fallen. Now you can send another email, but this time only to the 50,000 people who received a correct prediction. These 50,000 you divide into two groups: the first half learns that prices will increase next month, the second half discovers they will fall. Continue doing this. After 10 months, around 100 people will remain, all of whom you have advised impeccably. From their perspective, you are a genius. You have proven that you are truly in possession of prophetic powers. Some of these people will trust you with their money. Take it and start a new life in Brazil.
However, it’s not just naïve strangers who get deceived in this way; we constantly trick ourselves, too. For example, people who are rarely ill consider themselves immortal. CEOs who announce increased profits in consecutive quarters deem themselves infallible – their employees and shareholders do, too. I once had a friend who was a base jumper. He jumped off cliffs, antennae, and buildings, pulling the ripcord only at the last minute. One day, I brought up how risky his chosen sport is. He replied quite matter-of-factly: ‘I’ve over 1,000 jumps under my belt, and nothing has ever happened to me.’ Two months later, he was dead. It happened when he jumped from a particularly dangerous cliff in South Africa. This single event was enough to eradicate a theory confirmed a thousand times over.
Inductive thinking can have devastating results. Yet we cannot do without it. We trust that, when we board a plane, aerodynamic laws will still be valid. We imagine that we will not be randomly beaten up on the street. We expect that our hearts will still be beating tomorrow. These are confidences without which we could not live, but we must remember that certainties are always provisional. As Benjamin Franklin said, ‘Nothing is certain but death and taxes.’
Induction seduces us and leads us to conclusions such as: ‘Mankind has always survived, so we will be able to tackle any future challenges, too.’ Sounds good in theory, but what we fail to realise is that such a statement can only come from a species that has lasted until now. To assume that our existence to date is an indication of our future survival is a serious flaw in reasoning. Probably the most serious of all.
The above article is from the book The Art of Thinking Clearly by Rolf Dobelli. The article is only for educational and informative purposes to explain and understand cognitive biases. It is a great book, definitely worth a read!