A STOCK MARKET SCAM excerpted from from Innumeracy, Hill and Wang (Farrar, Straus), 1989 by John Allen Paulos, copyright.
Stock market advisors are everywhere, and you can probably find one to say almost anything you might want to hear. They're usually assertive, sound quite authoritative, and speak a strange language of puts, calls, ginnie maes and zero-coupons. In my humble experience most don't really know what they're talking about, but presumably some do.

If from some stock market advisor you received in the mail for six weeks in a row correct predictions on a certain stock index and were asked to pay for the seventh such prediction, would you? Assume you really are interested in making an investment of some sort, and assume further that the question is being posed to you before the stock crash of October 19th, 1987. If you would be willing to pay for the seventh prediction (or even if you wouldn't), consider the following con game.

Some would-be advisor puts a logo on some fancy stationery and sends out 32,000 letters to potential investors in a stock index. The letters tell of his company's elaborate computer model, his financial expertise, and inside contacts. In 16,000 of these letters he predicts the index will rise, and in the other 16,000 he predicts a decline. No matter whether the index rises or falls, a followup letter is sent, but only to the 16,000 people who initially received a correct "prediction". To 8000 of them a rise is predicted for the next week, to the other 8000 a decline. Whatever happens now, 8000 people will have received two correct "predictions". Again to these 8000 people only, letters are sent concerning the index's performance the following week, 4000 predicting a rise, 4000 a decline. Whatever the outcome, 4000 people now have received three straight correct predictions.

This is iterated a few more times until 500 people have received six straight correct "predictions". These 500 people are now reminded of this and told that in order to continue to receive this valuable information for the seventh week they must each contribute $500. If they all pay, that's $250,000 for our advisor. If this is done knowingly and with intent to defraud, this is an illegal con game. Yet it's considered acceptable if it's done unknowingly by earnest, but ignorant publishers of stock newsletters, or by practitioners of quack medicine, or by television evangelists. There's always enough random success to justify almost anything to someone who wants to believe.

There is another quite different problem exemplified by these stock market forecasts and fanciful explanations of success. Since they're quite varied in format and often incomparable and very numerous, people can't act on all of them. The people who try their luck and don't fare well will generally be quiet about their experiences. But there'll always be some people who will do extremely well, and they will loudly swear to the efficacy of whatever system they've used. Other people will soon follow suit, and a fad will be born and thrive for a while despite its baselessness.

There is a strong, general tendency to filter out the bad and the failed and to focus on the good and the successful. Casinos encourage this tendency by making sure that every quarter that's won in a slot machine causes lights to blink and makes its own little tinkle in the metal tray. Seeing all the lights and hearing all the tinkles, it's not hard to get the impression that everyone's winning. Losses or failures are silent. The same applies to well-publicized stock market killings vs. relatively invisible stock market ruinations, and to the faithhealer who takes credit for any accidental improvement, but will deny responsibility if, for example, he ministers to a blind man who then becomes lame.


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