G is for Gambler’s Fallacy

The Gambler's Fallacy occurs when someone believes that a run of a certain type in a random process makes a reversion more likely. A run of reds on a roulette wheel doesn't make black any more likely next time, but people persist in believing that it will. Equally a run of daily losses on a stock doesn't mean a profit is guaranteed tomorrow.

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Recency: Hot-Hands and the Gambler’s Fallacy

Behavioural Biases (6): Recency

Recency is a great trouble to us, being a particularly tricky sort of behavioural bias that’s rather difficult to overcome. It works thus: you overfocus on the most recent events you’ve experienced and neglect to worry about older information. We don’t so much integrate new information with the old as use it to overwrite our memories.

For investors recency may have a couple of different effects. Positive recency makes you a momentum trader, a sort of living incarnation of a goldfish, forever surprised by the same piece of seaweed. Negative recency makes you a contrarian investor, solidly heading away from anything exciting, looking for where the action isn’t. Either way you’d better be damn sure you know what you’re doing because both approaches more or less guarantee under-diversification.

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