The Hindu Business Line : Wisdom of crowds

A marine biologist, an aeronautics engineer, a doctor and a software geek got together to manage money. A year later, they comfortably beat the market. Their success can be primarily attributed to "methodological individualism."

If you decide to buy a car, it is highly unlikely that you will listen to your spouse or your mother-in-law while choosing the model. Economists call such decision-making "methodological individualism." That is, you arrive at your ideas of self-interest on your own.

Research has shown that if individuals in a group do not influence other members' decision process, the collective decision of the group tend to be better, no matter how dumb each member might be. The four people met once a week to discuss why they should buy a particular stock. Their diverse background helped them come up with crazy ideas that helped lift the group's collective wisdom.

A classic example is the way a US naval officer fiound a lost submarine. He assembled a team of people with diverse backgrounds and asked each of them to come up with ideas on why the submarine sank. Though none of them got the correct reason, the naval officer was able to arrive at a location where the submarine sank based on ideas from the members of the group.

There is, indeed, wisdom in numbers, as James Surowiecke argues in his book, The Wisdom of the Crowds. This provides an important lesson for investors/traders: It often pays to listen to the crowd — the stock market. It knows more than you do. Ask the chartists, they will agree.

(The author is based in Toronto, Canada)

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