Extrapolation Bias: The Double Edged Sword Of Humanity
Learn how to wield it, lest you end up on the wrong side of the blade.
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I'm sure you've heard of the phrase "be fearful when others are greedy, greedy when others are fearful". When inspected closely, the quote relates to humanity's skill of extrapolation - the ability to forecast future data based on present statistics.
Extrapolation is definitely a necessary skill we have developed - the ability to forecast future circumstances from present ones; say you don't live your best life right now - the skill allows you to have an inkling of what your life will be in 10, 20 or 30 years. Extrapolating into the future scares you into taking action today.
But in investing, this skill becomes a double-edged sword. Extrapolation bias is defined as the tendency to take a recent experience and project that it will continue into the future.
Does it make sense for you to believe that prices will go up infinitely forever during a bull run? Not really. Conversely, does it make sense for you to think that a stock/coin will go to zero just because it has a continuing downtrend? Probably not.
But the nuanced argument for extrapolation is this: would you open a short during a parabolic bull run? Or open a long when prices are crashing? (ahem, as seen on my CT TL lately)
Point is, things are rarely so black and white in life. And this skill is the same - one has to apply a multi-dimensional approach, taking into account macro-economic factors, narratives, technical indicators, etc.
Isolated extrapolation by itself especially when you're dealing with extremely volatile assets such as cryptocurrency trading at a beta to the traditional finance markets means that you very much cannot tell me that "fear is at its peak, this is the generational bottom" when macro-economic factors are as dire as ever before.
But if you have reason to believe that a long is a good play due to consideration of other factors - go ahead. Nothing I say is investment advice - I'm just educating you to not make one-dimensional decision making.
Just remember - always question your extrapolations; if mastered, this weapon can help you slay many demons.
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