Mental models: Feedback loop
A feedback loop occurs when the output of a system feeds back into itself as input, thereby further affecting the output, and so on.
Here is the definition from Wikipedia:
Feedback occurs when outputs of a system are routed back as inputs as part of a chain of cause-and-effect that forms a circuit or loop. The system can then be said to feed back into itself. The notion of cause-and-effect has to be handled carefully when applied to feedback systems:
Simple causal reasoning about a feedback system is difficult because the first system influences the second and second system influences the first, leading to a circular argument. This makes reasoning based upon cause and effect tricky, and it is necessary to analyze the system as a whole.
So, we might think that, if the output becomes the input, then the next output should be of higher intensity than the previous one. It’s not. Here’s why:
There are two types of feedback loops:
- Positive (reinforcing) and
- Negative (balancing or goal-based)
Positive feedback loops
In positive feedback loops, the outputs gets amplified (either increasing or decreasing intensity). In other words, if the input leads to an increase in output, then the loop will lead to continuously increasing output. If the input decreases the output, then the loop will lead to continuously decreasing output. The curve of positive feedback loop is exponential — either exponential growth, or exponential decline.
Confused? Let’s go over a few examples to get more clarity:
Stampede: In huge gatherings of people — for example, at festivals or events — a minor panic will lead to a few people running, which leads to more panic and more people running. This causes stampede, which will lead to a major disaster due to just minor panics. We can also see this in the stock market — in bubbles and bursts.
Bank runs: When a small number of depositors of a bank hear rumors that the bank is going to go broke (due to some negative news), they will run to the branches to withdraw their money. This news of depositors flocking to branches for money leads to more depositors following suit. This ultimately results in bank runs.
Microphones: When the sound from speakers feeds into the microphone, it is further amplified and sent out as a much bigger sound output, which is again fed into the microphone, and so on. This results in a loud high-pitched squeal. (I regularly experience this in our Church every Sunday.)
Learning: Feedbacks are important for learning based on deliberate practice. We learn, practice something, get feedback, adjust our methods based on feedback, and we do it again. This loop reinforces our learning, and helps us to improve. As we learn more, we will be able to understand higher-degree ideas, and this snowballs into a huge intellectual advantage over time. (And this is why I am writing this blog!)
Network effect: This is applicable to businesses. Let’s take the example of Facebook — we use Facebook because everyone else is on Facebook. As more users join in, the more useful the network is, and hence more users join in. Another example is eBay — customers go there because most suppliers are there. Most suppliers are there because most customers are there in eBay. It’s a loop. Chicken-egg logic.
There is a big problem with some positive feedback loops — they cause system instability. This is because, there is no mechanism put in place to ensure that the outputs go far out of tolerable limits. Stampedes, bank runs and squeal from speakers are examples. This uncontrolled movement ultimately could result in a collapse in the system. But some other positive feedback loops — like, stock market bubbles and bursts — have a mechanism which limits the damage. After the bubble reaches preposterous levels, it bursts, bringing the folly down to more sensible levels as investors cash out. Bursts and corrections ultimately result in bounce-backs, as investors buy in after they spot bargains.
Negative feedback loops
Negative feedback loops can also be called balancing or goal-seeking loops. In such systems, there is a set limit (or goal), and the aim of the feedback mechanism is to stick to the set limits, thereby maintaining a balance.
In the above chart, the system reaches the goal and maintains it. In cases where the feedback has a time lag, there will be oscillation around the goal, leading to overshooting and undershooting.
Let’s look at the real-world examples:
Our body : Human body maintains temperature like a thermostat. When temperature of our body increases beyond the set limit, our skins send signals to the brain, which in turn increases blood flow to cool it down. If temperature falls below a certain point, the blood flow is decreased, thereby raising the temperature. In fact, it is just not the temperature, but several of our body functions help in maintaining an equilibrium (e.g., blood glucose level). This process of maintaining equilibrium is called homeostasis.
Nature’s food chains: Mother nature maintains everything in equilibrium. The food chain is one of the best examples. See the below TED Ed video:
We encounter positive and negative feedback loops in life and investing. It is important to look at the system as a whole, and not the individual activity in isolation — because the cause-and-effect relationship has a circular reference (to borrow a term from Microsoft Excel terminology).
This post originally appeared on my blog My Investing Life.
