The Wisdom of Crowds

Surowiecki was asked: When is the mob smarter than the experts?

His response was that there are four fundamental characteristics that distinguish a smart crowd. It must be diversified in order for people to offer different perspectives to the table. It must be decentralised so that no one at the top can dictate the crowd's response. It requires a method of condensing people's opinions into a single aggregate decision. And the folks in the crowd must be self-sufficient, paying attention primarily to their own information rather than worrying about what everyone else thinks.

Picking up on these four concepts, let's apply them to the stock market.



1. Various. The stock market in the United States is diverse; people bring different information to it and express their various viewpoints and degrees of knowledge and experience through the prices they purchase and sell at in the market. So we know we have a diversified market, and according to Surowiecki, this feature in a market or a crowd contributes to its intelligence.



2. It is decentralised. Most stock exchanges are decentralised and rely on market forces to determine pricing.



3. The group decision. The aggregate opinion of the crowd is frequently a wiser decision than the individual decision. In the market, the collective verdict may be seen in two ways: first, through trend direction, and second, through the closing price of individual equities.



4. Individuality. The final attribute required in any crowd to help differentiate a smart crowd from a dumb one is the individual's own ideas and actions within the crowd. It is intimately related to the first diversity quality. When everyone acts separately, you have diversity, and when this diversity produces a common theme, such as a bullish trend, you know there must be something to it because so many people independently came up with the same answer. Our market, I believe, reflects this pattern.



After qualifying and expanding on Surowiecki's four qualities, I believe we can safely say that the crowd in our stock market is a smart crowd rather than a naive one, and I bring this up purposefully because so many commentators tell us that going against the crowd is the way to be successful as investors. They frequently advise us to go it alone and be self-sufficient. There is nothing wrong with being independent in and of itself, but if our individual decision making leads you in the opposite way of the rest of the market, it does not appear to be a wise choice.

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