Flaw of Averages

In Declining (Low) Volatility = Rising (High) Complacency I said:

“The VIX has a long-term average of about 20 since its inception. At this moment, it is 11.82. It’s important to realize the flaw of averages here, because the VIX doesn’t actually stay around 20 – it instead averages 20 as it swings higher and lower.”

The flaw of averages is the term used by Sam L. Savage to describe the fallacies that arise when single numbers (usually averages) are used to represent uncertain outcomes.

A fine example of the flaw of averages involves a 6 ft. tall statistician who drowns while crossing a river that is 3 ft. deep on average.

 

DanzigerCoverArtSavage

Source: http://www.danzigercartoons.com/

You can probably see how assumptions using averages can get us in trouble. It only takes a little to be “too much”… and that is mostly likely a problem when we expect the average and the possible range is much wider.