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“This is a masterpiece.”
—Morgan Housel, Author, Psychology of Money
“Discover the extraordinary within.”
—Manish Chokhani, Director, Enam Holdings
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The Internet is brimming with resources that proclaim, “nearly everything you believed about investing is incorrect.” However, there are far fewer that aim to help you become a better investor by revealing that “much of what you think you know about yourself is inaccurate.” In this series of posts on the psychology of investing, I will take you through the journey of the biggest psychological flaws we suffer from that causes us to make dumb mistakes in investing. This series is part of a joint investor education initiative between Safal Niveshak and DSP Mutual Fund.
There is a story about a turkey that Nassim Taleb shared in The Black Swan.
Every single morning for 1,000 days, the butcher feeds the turkey food it loves. Over time, the turkey gets bigger and feels happy.
From the turkey’s point of view, the butcher is his best friend. Why wouldn’t it be? The turkey has 1,000 days of proof that this man takes care of him. It feels totally safe. So, when day 1,001 comes around, the turkey has no reason to worry. In fact, it is absolutely sure it’s going to be another great day.
The 1,001st day is Thanksgiving. The turkey is butchered.
The turkey’s mistake wasn’t a lack of intelligence. It simply assumed that because things had gone well for a long time, they would continue to go well. This is the deeper trap Taleb warns about, which is the danger of letting past patterns fool us into believing they will extend into the future.
A close cousin of this trap shows up as the Hot-Hand Fallacy, which is the belief that a recent streak signals that more success is likely ahead. Where the turkey trusted stability, investors often trust momentum. And although these mistakes look different on the surface, they come from our brain’s habit of turning yesterday’s pattern into tomorrow’s expectation.
That is where trouble usually begins.
The first time the Hot-Hand Fallacy was described was in 1985, in a study by Thomas Gilovich, Amos Tversky, and Robert Vallone. They studied basketball data and challenged the popular belief that a player who has just scored is somehow “in the zone” and therefore more likely to score again. Their analysis suggested that what fans celebrated as a mysterious surge of confidence or rhythm was, in most cases, simply randomness being misunderstood.
Now, the human mind dislikes randomness. We prefer patterns because patterns make the world feel predictable. And so, even when numbers reveal no such “momentum,” the mind insists on creating it.
This tendency, that success must continue simply because it has already occurred, is the essence of the Hot-Hand Fallacy. And while it may seem like an amusing quirk of sports psychology, its real playground is far more consequential. We call it the stock market.
Think about a friend who buys a stock solely because it had doubled in a short period. When you ask him why he thought the rise would continue, he points to the chart as though it contains divine instructions. This is the investor’s version of passing the ball to the “hot” player, or believing a rising line possesses some inner propulsion of its own.
The truth, which is simpler and less comforting, is that a price moves because people are transacting at that price. Nothing in that movement guarantees what tomorrow will bring. But our brain evolved at a time when patterns were tied to survival. If berries were found twice under a particular tree, it made sense to assume the area was fertile. Markets, unfortunately, grow illusions and not berries.
Now, this seductive nature of streaks appears in many forms in the markets.
A fund manager who beats the market for two years is assumed by investors to have cracked some secret code.
An investor who correctly anticipates a few earnings results begins to imagine he has unlocked deeper insight.
A sector that climbs steadily acquires ready-made explanations, often recited with great confidence.
In each case, a short burst of success becomes a story of brilliance and inevitability. But what feels like a pattern is often just a statistical accident. Tversky, who spent a lifetime studying cognitive distortions, once observed that people are “remarkably poor” at telling chance apart from causation. The stock market adds an emotional twist to this weakness. Given that money is involved here, randomness begins to look like personal skill.
After a few winning decisions, even sensible investors begin to feel a faint glow of invincibility. The internal voice says, “You’ve figured it out,” and suddenly the streak becomes part of one’s identity. The investor who has enjoyed a series of correct decisions feels as though the universe is finally rewarding him for his intelligence. This is exactly when judgment starts to wobble.
Every bull market contains its catalogue of stocks or mutual funds that appear unstoppable. They become the heroes of dinner conversations and, for a brief moment, they seem immune to gravity. Then, as always, gravity returns. History is littered with companies whose “invincible” streaks broke abruptly. The fall always looks obvious in hindsight, never during the rise.
Now, a better way to approach streaks is not to treat them as predictions, but as prompts for deeper inquiry. When a stock has been rising, the important question isn’t whether the rise will continue, but what underlying conditions justify the movement. Are the fundamentals improving, or is this simply enthusiasm chasing itself? Is the recent performance durable or temporary? Most importantly, if you had no information about the stock’s recent price action, would you still be interested in owning it? That single question strips the hypnotic effect from the chart and forces the mind back toward reality.
Buffett captured this wisdom when he wrote:
“What the wise do in the beginning, fools do in the end.”
Now for the question: how can you avoid the Hot-Hand Fallacy or minimise its impact on your financial life?
Well, like all biases and fallacies, it requires no special intelligence, just a willingness to separate emotion from evidence.
It involves reminding oneself that markets are inherently unstable, and therefore past success carries no obligation into the future.
It involves resisting the pleasure of believing that our recent successes reflect our skill rather than a mix of randomness and luck.
Above all, it requires humility to recognise that streaks can end with the same abruptness with which they began.
A winning streak is a wonderful thing to experience. Savour it.
Just don’t bank on it. Because the butcher may come anytime, and he won’t care about the story you’re telling yourself.
Disclaimer: This article is published as part of a joint investor education initiative between Safal Niveshak and DSP Mutual Fund. All Mutual fund investors have to go through a one-time KYC (Know Your Customer) process. Investors should deal only with Registered Mutual Funds (‘RMF’). For more info on KYC, RMF & procedure to lodge/ redress any complaints, visit dspim.com/IEID. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Two Books. One Purpose. A Better Life.
“This is a masterpiece.”
—Morgan Housel, Author, Psychology of Money
“Discover the extraordinary within.”
—Manish Chokhani, Director, Enam Holdings
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