The Dunning-Kruger Effect is a cognitive bias in which people with low ability at a given task are prone to overestimate their ability at that task.
Put simply, humans are notoriously incapable of objective evaluation of their competency levels.
Dunning-Kruger Effect 101
In a year when the markets have minted many new self-proclaimed geniuses, it is worth remembering the Dunning-Kruger Effect.
But what is the Dunning-Kruger Effect and how does it work?
Here's Dunning-Kruger Effect 101!
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The Dunning-Kruger Effect is a cognitive bias in which people with low ability at a given task are prone to overestimate their ability at that task.
Put simply, humans are notoriously incapable of objective evaluation of their competency levels.
Their paper, entitled Unskilled and Unaware of It, summarized, "People tend to hold overly favorable views of their abilities in many social and intellectual domains."
He hadn't worn a mask.
Instead, he had put lemon juice on his face, believing it would make him invisible to cameras.
Even after he was caught, he was legitimately incredulous that his plan with the lemon juice hadn't worked.
Their finding: the worst performers consistently overestimated their abilities relative to others.
Let's look at a few examples of this bias in action and how you can avoid its pitfalls.
As the saying goes, "everyone is a genius in a bull market."
When markets are ripping and your portfolio seems to grow by the day, many fall victim to the Dunning-Kruger Effect.
We may wrongly attribute this performance to our innate talent as investors.
With politics, intellectual humility is an aberration, not the norm.
Politicians espouse policy ideas with great confidence even if they have a weak handle of the details.
It's not shocking that we see Cobra Effects in the policy realm. https://t.co/gKuHcJTjW7
Cobra Effect 101
— Sahil Bloom (@SahilBloom) October 21, 2020
With the rise of government and central bank intervention in the economy and markets, the term "cobra effect" has experienced a revival.
But what is a "cobra effect" and how does it work?
Here's Cobra Effect 101!
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Everyone has had that one boss - the know-it-all who actually knows very little.
These bosses (who typically get stuck in middle management) hold back organizations from high performance.
They are easy to spot - we all know who they are.
Beware this boss!
So how do we avoid it?
Here are a few strategies.
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The Circle of Competence is the set of topic areas that align with a person's expertise.
Be ruthless in identifying and protecting the boundaries of your Circle of Competence.
Hint: it's usually smaller than you think.
Most people have an inherent discomfort with saying, "I don't know."
Change that. Embrace what you don't know.
The world would be a much better, more efficient place if we stripped out the fluff and cut to the "I don't know" chase.
Think you know something? Challenge yourself, your reasoning, and your assumptions as a matter of practice.
It's uncomfortable, but it is also essential to creating non-linear outcomes. https://t.co/31EZVZDLM1
First Principles 101
— Sahil Bloom (@SahilBloom) November 19, 2020
Many of the world's greatest thinkers and doers - from @naval and @elonmusk to @nntaleb and @chamath - tout the importance of first principles thinking.
But what is "first principles thinking" and how does it work?
Here's First Principles 101!
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Know your competencies, focus on them.
Know your incompetencies, avoid (or outsource) them.
So the next time you catch yourself marveling at your skill at a task, remember the Dunning-Kruger Effect and the strategies for avoiding it.
For more on this topic, check out the resources below:
https://t.co/5TpIxyWjCD
https://t.co/mYfcPw2rcH
https://t.co/9lmroooQHn
https://t.co/2rlAXpPGt6
https://t.co/sAqJLE1gJi
https://t.co/5vAlRTbi5u
For more educational threads on business, money, finance, and economics, follow me on Twitter and check out my meta-thread below. https://t.co/53UhhfzIcp
1/ An Allegory of Finance
— Sahil Bloom (@SahilBloom) July 18, 2020
I have been posting a lot of educational (and humorous!) threads on finance, money, and economics.
My mission is simple: to demystify these concepts and make them accessible to everyone.
All of the threads can be found below. Enjoy and please share!
More from Sahil Bloom
Short Squeeze 101
If you follow financial markets (or if you watch Billions), you've heard the phrase "short squeeze" used quite frequently.
But what is a "short squeeze" and how does it work?
Here's Short Squeeze 101!
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1/ First, the basics.
The "short" in "short squeeze" refers to the concept of short selling.
The basics are covered in my thread below.
https://t.co/xecJYNCxMs
TL;DR - short selling is a way of betting against a stock - i.e. betting that its price will decline.
2/ "Short interest" is a measure of how heavily an asset is shorted by the market.
It is the total number of shares that have been sold short (borrowed and sold), but have not yet been covered (bought and returned).
It is usually measured as a % of the # of shares outstanding.
3/ A "short squeeze" occurs when a heavily-shorted asset experiences a rapid upward price movement.
When this happens, short sellers may be forced to close their short positions (i.e. buy the stock and return it to the broker), further accelerating the upward price movement.
4/ Let's look at a simple example to show this in action.
We will use Tesla, one of the most heavily-shorted stocks in the world.
Imagine the stock price is $1,000 per share. This seems crazy. Ricky Rational decides to short the stock at this level.
If you follow financial markets (or if you watch Billions), you've heard the phrase "short squeeze" used quite frequently.
But what is a "short squeeze" and how does it work?
Here's Short Squeeze 101!
👇👇👇
1/ First, the basics.
The "short" in "short squeeze" refers to the concept of short selling.
The basics are covered in my thread below.
https://t.co/xecJYNCxMs
TL;DR - short selling is a way of betting against a stock - i.e. betting that its price will decline.
1/ Short Selling 101
— Sahil Bloom (@SahilBloom) July 6, 2020
With the markets continuing to rally, there has been more talk of \u201cshorting\u201d or \u201cshort selling\u201d stocks.
But what does that mean and how does it work?
Here\u2019s a quick educational primer: Short Selling 101 pic.twitter.com/JTrJmuY7fI
2/ "Short interest" is a measure of how heavily an asset is shorted by the market.
It is the total number of shares that have been sold short (borrowed and sold), but have not yet been covered (bought and returned).
It is usually measured as a % of the # of shares outstanding.
3/ A "short squeeze" occurs when a heavily-shorted asset experiences a rapid upward price movement.
When this happens, short sellers may be forced to close their short positions (i.e. buy the stock and return it to the broker), further accelerating the upward price movement.
4/ Let's look at a simple example to show this in action.
We will use Tesla, one of the most heavily-shorted stocks in the world.
Imagine the stock price is $1,000 per share. This seems crazy. Ricky Rational decides to short the stock at this level.
THREAD: With #silversqueeze trending on Twitter, it appears that this week's market spectacle may well be in the silver market.
A perfect moment for a thread on the Hunt Brothers and their alleged attempt to corner the silver market...
1/ First, let's set the stage.
The Hunt Brothers - Nelson Bunker Hunt, William Herbert Hunt, and Lamar Hunt - were the sons of Texas tycoon H.L. Hunt.
H.L. Hunt had amassed a billion-dollar fortune in the oil industry.
He died in 1974 and left that fortune to his family.
2/ After H.L.'s passing, the Hunt Brothers had taken over the family holdings and successfully managed to expand the Hunt empire.
By the late 1970s, the family's fortune was estimated to be ~$5 billion.
In the financial world, the Hunt name was as good as gold (or silver!).
3/ But the 1970s were a turbulent time in America.
Following the oil crisis of the early 1970s, the U.S. had entered a period of stagflation - a dire macroeconomic condition characterized by high inflation, low growth, and high unemployment.
4/ The Hunt Brothers - particularly Nelson Bunker and William Herbert - believed that the inflationary environment would persist and destroy the value of their family's holdings.
To hedge this risk, they turned to silver.
They began buying the metal at ~$3 per ounce in 1973.
A perfect moment for a thread on the Hunt Brothers and their alleged attempt to corner the silver market...
1/ First, let's set the stage.
The Hunt Brothers - Nelson Bunker Hunt, William Herbert Hunt, and Lamar Hunt - were the sons of Texas tycoon H.L. Hunt.
H.L. Hunt had amassed a billion-dollar fortune in the oil industry.
He died in 1974 and left that fortune to his family.
2/ After H.L.'s passing, the Hunt Brothers had taken over the family holdings and successfully managed to expand the Hunt empire.
By the late 1970s, the family's fortune was estimated to be ~$5 billion.
In the financial world, the Hunt name was as good as gold (or silver!).
3/ But the 1970s were a turbulent time in America.
Following the oil crisis of the early 1970s, the U.S. had entered a period of stagflation - a dire macroeconomic condition characterized by high inflation, low growth, and high unemployment.
Stagflation 101
— Sahil Bloom (@SahilBloom) September 2, 2020
The term "stagflation" is used frequently in discussions of monetary policy and risks in the post-COVID world.
But what is stagflation and how does it work?
Here's Stagflation 101!
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4/ The Hunt Brothers - particularly Nelson Bunker and William Herbert - believed that the inflationary environment would persist and destroy the value of their family's holdings.
To hedge this risk, they turned to silver.
They began buying the metal at ~$3 per ounce in 1973.
