by Cullen Roche, Pragmatic Capitalism
If there’s one cognitive bias you have to be particularly aware of in the markets, it’s recency bias. Recency bias is the tendency to believe that what has just recently occurred is likely to form part of a larger future trend. It’s dangerous, you should become extremely familiar with it, learn from it and ensure that you don’t fall for it.
If you’ve been paying attention to the market rally over the last 6 months you’ve certainly heard of the Tuesday winning streak that just came to an end. Yes, the S&P 500 rallied in 20 consecutive Tuesdays. Pretty amazing, right? No, it’s meaningless. This is a classic case of recency bias or the gambler’s fallacy. In the gambler’s fallacy one looks at a series of recent events and concludes that this makes a future event more likely to occur. It’s like flipping a coin that lands on heads 10 times in a row and then concluding that that either makes the next flip more or less likely to be a heads. Of course, each flip is its own independent action and has no influence on the next flips, but that doesn’t stop people from falling for this myth.