Leveraged Growth
May 19, 2021
Leveraged Growth, Leveraged Growth

CLUSTERING ILLUSION

Everyone is susceptible to illusions!

Cognitive biases have a significant impact on how our brain functions. It influences how we make decisions in our daily life. One such cognitive bias is Clustering Illusion. It is an illusion wherein we perceive a small sample of random data sets to be non-random and revealing a pattern such as seeing shapes in clouds. Understanding such illusions and taking steps to avoid such bias would help in proper decision-making in fields such as management, market research, and investment.
Research shows that the correlation between the returns of mutual funds for two consecutive years is barely higher than zero. And yet, we tend to invest in these funds looking at the past performance – Clustering Illusion at its best. 

These instances show how Clustering Illusion affects our choices and decisions. It is just another example of how we create false perceptions that need to be challenged through rigorous analysis, patience, and critical thinking. Knowing about this phenomenon can certainly help in skewing events to our advantage.

Clustering
Illusion
refers
to
a
cognitive
bias
wherein
the
human
mind
tends
to
frame
or
find
connections
between
random
pieces
of
information
in
a
sample
set
.
It
perceives
random
data
sets
to
be
non
-
random
.
This
often
leads
to
foul
judgement
and
deviation
from
the
sense
of
rationality
.
The
tendency
to
seek
patterns
in
whatever
we
visualize
to
speed
up
the
process
of
recognizing
objects
and
making
decisions
.
We
are
prone
to
jump
to
immediate
conclusions,
known
as
‘Law
of
Least
Effort
.
Under
-
predicting
the
discrepancies
that
are
likely
to
occur
in
a
small
sample
of
random
data
sets
.
The
market
can
be
random
at
times
and
charts
often
do
not
imply
any
pattern
in
the
short
run
.
Most
short
term
volatility
is
noise
and
should
be
avoided
.
Stock
price
movements
tend
to
follow
a
random
walk
and
few
consecutive
high
ticks
do
not
reveal
a
trend
.
Clustering
illusion
may
impel
us
to
find
patterns
in
such
short
periods
.
So,
make
trades
only
after
hard
statistics
and
careful
analysis
.
Why Does this Happen?
Charts can be Illusionary!
How to Tackle this Illusion?
Gather
enough
Data
:
To
make
any
conclusions
gather
enough
data
.
Results
differ
when
made
from
10
%
data
and
50
%
data
.
Question
your
instinct
:
Approach
decisions
with
a
fair
amount
of
scepticism,
although
striking
a
good
balance
between
being
delusional
and
doubting
too
much
.
‘Have
strong
opinions,
loosely
held’
Do
not
place
too
much
emphasis
on
short
-
term
performance
:
Good
or
bad
streaks
in
the
short
term
are
highly
influenced
by
many
different
factors
including
luck
.
Study
the
data
intensively
before
making
any
decision
.
Investors
are
always
cautioned
before
investing
in
mutual
funds,
and
asked
not
to
base
their
expectation
of
future
results
on
past
performance
as
previous
returns
might
be
from
sheer
luck
.
While
analysing
the
past
returns
of
a
fund,
one
might
be
prone
to
clustering
illusion
bias
.
Using
short
-
term
performance
analysis,
one
might
be
compelled
to
invest
in
one
fund
over
another
or
in
a
particular
asset
or
to
follow
a
specific
investing
style
.
Do
not
let
clustering
illusion
deceive
you!
‘Past Performance is Not Indicative of Future Results’