Humans are very bad at figuring out how correlated two variables are. A correlation between variables does not automatically mean that the change in one variable is caused by the change in the values of the other variable. This is a problem because some people can assume a correlation between two things, when that correlation does not exist. A silly example that might help you understand this concept can be about the growth of trees and mattress factories. If trees tended to flourish near mattress factories, saying that mattress factories help trees to grow better would be incorrect. A lot of young investors who make a lot of money due to the market make the mistake of correlating increase in the market to their own skill. This cannot be further from the truth due to the fact that when the market is in this state, it is harder to lose money than it is to gain it. The equity prices increasing is mainly due to luck, and so cannot be correlated to the brilliance of the investor.
Another way to look at this problem is through an invisible/illusory correlation. Invisible correlations are when one outcome is overemphasizing, causing the other outcomes to be neglected. An instance of this is if the investor buys a stock of a company on every Friday, and for the whole month of May that stock resulted in a loss on the coming Monday when the market reopened. This investor then assumed that buying a stock on a Friday will make him lose money, and therefore stopped buying stocks on Fridays. This is an example of the illusory correlation, because the investor was overemphasizing the outcome of buying stocks on a Friday, without looking at the times before May where the prices were going up. He neglected this outcome because it is easier to remember negative outcomes than positive ones.
Citations:
“Correlation and Causation | Lesson (article).” Khan Academy, https://www.khanacademy.org/test-prep/praxis-math/praxis-math-lessons/gtp--praxis-math--lessons--statistics-and-probability/a/gtp--praxis-math--article--correlation-and-causation--lesson. Accessed 29 November 2023.
“Correlation vs Causation: Understand the Difference for Your Product.” Amplitude, https://amplitude.com/blog/causation-correlation. Accessed 29 November 2023.
Source for image: https://imgs.xkcd.com/comics/correlation.png
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