Clustering illusion

The problem with manual trading is that we see patterns where they don’t exist. It’s like staring at the clouds. — Jon Kafton

Clustering illusion is one of cognitive biases, the tendency to erroneously overestimate the importance of small runs in small samples of largely random data and underestimate variability (i.e., seeing phantom patterns).

The largest example of clustering illusion in trading and investing is, of course, — a thing called “chartism” — the use of charts of financial data to predict future trends and to guide investment decisions, which is like predicting tomorrow’s weather out from seeing faces in the clouds.

Chartism has a large community behind it, because it exploits evolutionary programmed brain’s agency search module, which always tries to give labels and meaning to any experienced events, which, taking into account the law of large numbers, are actually random.

Chartism has some very flexible rules that are impossible to test and prove, but also all those rules can also be easily changed into equally meaningless ones:

Personal test

Is “OXXXOXXXOXXOOOXOOXXOO” random?

Most of us will see patterns, but it is, actually, completely random.

If patterns are incorporated into pitches, people would see them as more truthful, but in trading this, as a lot of other biases are plain dangerous.