The Wisdom of Crowds

“...an investor who proposes to ignore near-term market fluctuations ... will in practice come in for most criticism, wherever investment funds are managed by committees or boards or banks. For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

“Professional investment may be likened to those for newspaper competitions in which competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of other competitors, all of whom are looking at the problem from the same point of view.”

Andreassen divided students into two groups. Each group selected a portfolio of stocks, and knew enough about each stock to come up with what seemed like a fair price for it. Then Andreassen one group to see only the changes in the prices of their stocks. They could buy and sell if they wanted, but all they knew was whether the price of a stock had gone up or down. The second group was allowed to see the changes in price, but was also given a constant stream of financial news that supposedly explained what was happening. Surprisingly, the less-well-informed group did far better than the group that was given all the news... the students who had access to the news overreacted... The students who could look only at the stock’s price had no choice but to concentrate on the fundamentals that they had used to pick their stocks to begin with.

The banal but key point I’m trying to make is that the more important the decision, the less likely a cascade is to take hold.

Diversity of opinion: “Collective decisions are only wise when they incorporate lots of different information.” If everyone thinks the same way and has the same background, a crowd will be no smarter than an individual. The individuals in the crowd need to bring their own experiences and knowledge to be effective.
Independence: When one person makes a prediction after hearing other people’s first, this can affect the outcome and cause a “cascade” effect. “The problem,” he says, “starts when people’s decision are not made all at once but rather in sequence…People fall in line because they believe they’re learning something important from the example of others…after a certain point it becomes rational for people to stop paying attention to their own knowledge—their private information—and to start looking instead at the actions of others and imitate them.”
Decentralization: “The virtues of decentralization are twofold. On the one hand, the more responsibility people have for their own environments, the more engaged they will be…The second thing decentralization makes easier is coordination. Instead of having to make constant resort to orders and threads, companies can rely on workers to find new, more efficient ways of getting things done.”
Aggregation: Crowds are useless if the diverse opinions are not aggregated in some way. This is often the downfall of decentralization: “Decentralization’s great weakness is that there’s no guarantee that valuable information which is uncovered in one part of the system will find its way through the rest of the system.”

We think that experts will identify themselves, announcing their presence and demonstrating their expertise by their level of confidence. But it doesn't work that way. Strangely, experts are no more confident in their abilities than average people are. Knowing and knowing that you know are apparently two very different skills.

Flawed as the first-come, first-served rule may be, it has a couple of advantages. To begin with, it's easy. When you get on the subway, you don't have to think strategically or worry about what anyone else is thinking. If there's an open seat and you want to sit down, you take it. Still, there's no law preventing you from trying to circumvent the convention by, for instance, asking someone to give up his seat. [Social psychologist Stanley Milgram and his students] reported that about half the time, just asking convinced people to give up their seats. But the hard part of the process wasn't convincing the people, it was mustering the courage to ask them in the first place. Much of the time, they couldn't even bring themselves to ask the question. The norm of first-come, first-served was so ingrained that violating it required real labor.

The rules of the ultimatum game are simple. The experimenter pairs two people. They're given $10 to divide between them, according to this rule: One person (the proposer) decides, on his own, what the split should be. He then makes a take-it-or-leave-it offer to the other person (the responder). The responder can either accept the offer, in which case both players pocket their respective shares of the cash, or reject it, in which case both players walk away empty handed. If both players are rational, the proposer will keep $9 for himself and offer the responder $1, and the responder will take it. In practice, though, this rarely happens. Instead, lowball offers--anything below $2--are routinely rejected. People would rather have nothing than let their \""partners\"" walk away with too much of the loot. . . . It isn't just humans who act this way, either. Female capuchin monkeys trained to trade a pebble for a slice of cucumber made the exchange 95 percent of the time when working in pairs. This idyllic market economy was disrupted, though, when the scientists changed the rules, giving one capuchin a delicious grape as a reward while still giving the other a cucumber slice. Confronted with this injustice, the put-upon capuchins often refused to eat their cucumbers, and 40 percent of the time stopped trading entirely.