Crowd-Sourcing is working for VC, do you think it could work for trading accounts?

Discussion in 'Trading' started by Brom, Nov 20, 2010.

  1. Brom


    LONG time lurker to this forum here.

    We live in an age where crowd-sourcing is being applied to something new everyday, and usually quite successfully. It just recently became applied to Venture capital ( and I think it's only a matter of time before it ends up being an alternative way to manage investment accounts. I'm interested to hear some of your opinions on this. I personally think that a crowd (especially if that crowd had some soft limits) managed fund could beat most mutual funds. If there was something like this in existence, what would it take for you to get involved?

    I only ask because I'm spearheading a project that will hopefully make the crowd managed fund a reality in the near future (don't worry, we have a great seclawyer on our team!). You can check out our page at and if you would be interested in being part of this, you can get on the waiting list for a beta invite (just fyi, the beta group is going to be paper style for a while before we actually allow people to invest real money).

    I'm also just interested in any discussion about crowd sourcing applied to financial markets. What are your thoughts?

  2. zdreg


    In 2007 Michael Mauboussin presented a big jar of jelly beans to his seventy-three Columbia Business School students. How many beans did they think it contained?

    Guesses ranged from 250 to 4,100; the actual number was 1,116. The average error was 700 — a massive 62% — demonstrating that the students were awful estimators.

    Now here comes the weird part. Even with all these wildly incorrect guesses, the average guess was 1,151 — just 3% off the mark. Not only that, only 2 of the 73 students guessed better than this group average.

    So although individually everyone was woefully inaccurate, collectively the group was incredibly accurate.

    Was this a fluke? Hardly. The experiment was made famous in 1987 by Jack Treynor. In his case it was 850 jelly beans and 56 students. The group estimate was 2.5% off; only one student guessed better. The study has been repeated many times since with similar results.

    This eerie effect goes beyond jelly beans; it's also a big help when you're trying to make money on TV.
    he best multiple-choice test, ever
    A contestant on the game show Who Wants to be a Millionaire can win a million dollars if she answers fifteen consecutive multiple-choice questions. If she's stumped along the way she has three "life-lines:" (1) eliminate two of the four choices, (2) telephone a friend, or (3) poll the audience. The jelly bean experiments imply that this third choice might be pretty good. Is there as much wisdom in the crowd for pop culture and science as there is in counting jelly beans?

    The TV studio audience predicts the correct answer an astonishing 91% of the time. Remember, these are questions from all domains of knowledge, all ranges of difficulty, polling a group of people who happened spend the (weekday) afternoon in a TV studio.

    To quantify how amazing that is, compare with the accuracy of the "phone a friend" life-line where the contestant gets 30 seconds with a pre-determined person. This accomplice is probably considered to be "the smartest person I know," plus undoubtedly has access to the web of lies Google and Wikipedia.

    The intelligent friend with broadband access to the entirety of human knowledge gets it right only 65% of the time.

    Crowd wins again.

    Is the rule universal?
    There's seemingly no end to studies like these, all showing that the crowd is smarter than the individual. Is this a universal rule? Should we be leveraging this power more often?

    Big companies do use crowd wisdom. You always hear about advertising campaigns being honed by focus groups of "real people." (I'd like to see the questionnaire that distinguishes "real people" from that elusive other kind of person.)

    However, company messaging, product features, advertising layouts, and the other creative aspects of business require innovation, and we know that design-by-committee is the antithesis of innovation. Average products designed for the average consumer is the path to small business failure.

    So what should we do? Can we rely on the wisdom of the collective or should we trust a stroke of inspiration?

    Analysis of how "crowd wisdom" works
    Let's take another look at Who Wants to be a Millionaire.

    Suppose there are 100 people in the audience and only 16 of them know that "A" is the correct answer. Of the rest, none knows the answer and they vote randomly. The result of the vote will be: 37, 21, 21, 21:

    Oh gee, it's awfully similar to the graphic earlier of a real audience poll.

    (For those of you so inclined, it's fun to try more complex scenarios, although you'll find the result is always similar. For instance, what if only 11 know the answer is A, 15 each know that B, C, or D are certainly not the answer (and vote randomly for the other three), and the remaining 44 have no clue and vote randomly. In this scenario, the vote distribution is the same as in the given example!)

    So we have the interesting result that a mere 16% of the voters were able to make choice A the clear winner — nearly double the next closest answer. The reason? The ignorant people vote randomly and their votes cancel out, leaving the rest in control of the result.

    The crowd vetoes innovation
    Now that we understand how crowds can be right, let's see why this same process doesn't work for creative endeavors.

    Consider what happens when you're planning a holiday meal. There's a range of fantastic things you could cook, but wait: Some people can't take spicy food, Uncle Bill is allergic to garlic, Aunt Sarah doesn't eat red meat, Timmy doesn't eat anything green, ....

    Eventually you realize there's only way to please everyone: Cook something bland, mild, and safe, like chicken and rice. But does chicken and rice actually please anyone? Not really, it was just what everyone hated the least.

    Votes don't converge on something wonderful. Rather, votes are vetoes.

    Of course if you're a catering company for weddings, chicken and rice might be the way to go! After all, no one goes to weddings for the food, so your primary goal is to piss off as few of the 300 guests as possible. Come to think of it, chicken and rice does seem to be popular at those sorts of functions...

    But this isn't a strategy for startups. Little companies need a niche — a market space they can completely, unquestionably own, not some gray middle-ground where your attempt to offend no one also means exciting no one.

    There is "wisdom in the crowd" only when errors cancel out, like when estimating jelly beans or answering pop culture questions. In creative work, votes eliminate the interesting edges, leaving only the boring residue that no one hated enough to vote off the island.

    That's not how great products are made.

    Further Reading

    * James Surowiecki's The Wisdom of Crowds, with more stories and implications for Wall Street. He also writes a terrific financial column and blog for The New Yorker.
    * Scott Page's The Difference, explaining how diversity makes a group smarter. The inspiration for my Who Wants to be a Millionaire example.
  3. I think you are inverting the concept. Normally, it would be a place one could find funds managers who will bid for lowest fees/highest quality of service based on audited reports.

    You are pooling investors together. This is not crowd-sourcing. This is your typiocal fund/pool operator. Read the first two lines of the wiki link you gave:

    "Crowdsourcing is the act of outsourcing tasks, traditionally performed by an employee or contractor, to an undefined, large group of people or community (a crowd), through an open call."

    I think it was discussed here extensivelly and Ninna gave the best mathematical answer why this will not have any advantages. There are many funds out there already with great performance and very low fees. Even if the fee is very high, if a fund has an average annual return of 20% it will be preferred.

    The main problem is, based on what track record are you inviting people to join a managed pool? Who is the manager of the pool?
  4. achilles28


    I'm a huge believer in the potential of crowd-sourcing and x-prize type collaboration.

    I think it could destroy today's productivity and creativity benchmarks.

    That said, for trading accounts? Yes, although with a twist.

    Crowd sourcing works because it draws on a pool of intellectual capital many orders of magnitude larger than the organization who solicits it. 100,000 brains looking for the best solution instead of 5. Or 10.

    Retail trading contests are pretty similar to what you propose, albeit operating under a different moniker. I would bet everything I own, the top 10 or 20 contest winners that generate staggering returns - with reasonable position sizing - are introduced to the prop desk, or third party funds.

    So, call it what you want, but you need to start a trading contest, define the rules to eliminate ridiculous position sizing, put up a big cash prize (200K +), then advertise in 1st world and 3rd world nations alike.

    You're looking for great traders to sign. I doubt there's much synergy to be had in the realm of collaborative investing/speculating.

    And in reality, this is what retail prop shops already do. They're just more coy about it. They leverage x-prize type crowd sourcing to identify great traders to trade house money...

    Now just copy and do it for yourself.
  5. Claudius


  6. nLepwa


    I think that crowd-sourcing doesn't do well with the power-law distribution of successes.

    You are on the wrong side of the fence. The business model that works (retail brokers) is betting agaisnt the crowd, not with it.

    However I do think that crowd-sourcing can be applied to finance.

    We work on mining twitter data for generating various models.
    The results are promising.

  7. You are absolutely correct. One forex broker is even advertising it without realizing it is doing so.
  8. They do not even have to. You may give the wrong impression that they do it intentionally (although some do). After you subtract commissions and slippage, the average trader who does not have an edge is engaged in a negative sum game, or has negative bias. The gains are fairly normally distributed with a negative mean, some traders will lose everything, some will make a fortune but most will lose a good percentage of their starting equity.

    This is why the best business is starting a forex brokerage. The problem is in a few years there will be more brokers than traders.
  9. LeeD


    I don't think it is the current trend. The inflow of new brokerages is offset by brokers going out of business or being a victim of acquisition. If anything, with ever tougher regulatory requirements the number of brokers is getting lower.
  10. sjfan


    This idea is brain dead on arrival. The entire market place is by definition 'crowd sourced'. Prices are the result of the interaction of hundreds of thousands of market participants. Wouldn't a 'crowd sourced' fund just be an index fund? (arguably, index funds outperform mutual funds - at least according to Vanguard).

    So what exactly are you offering other than buzz words and a completely ignorance of the financial markets.

    #10     Nov 20, 2010