Have you ever been “on fire”? The Hot Hand Fallacy

Written by John Kuder

Table Of Contents


Good morning. Hi, good morning. Good morning. Welcome to our world, or whatever time it is in your world. . So today we are talking about another cognitive bias. This one is closely related to one we covered previously, which was the gambler’s fallacy. Oh yeah. The one where, where we could well, if, if you, if you flipped like 10 10 heads in a row, you, you were, it was the next one was definitely gonna be tales had to change.

Ah, yeah. Oh, cuz the odds just were way outta whack. Yeah. Okay. Well, so what’s this one? This one’s called the Hot Hand Fallacy . And they’re like, I think I like that First Cousins or something. They’re, it’s almost the opposite. It’s very, very closely related. So the almost the opposite, but closely related.

Well, it’s, it’s, yes. Yeah. And you’ll see they’re, they’re okay. In fact, you can, you can almost apply them both in a, in a, in the same situation, depending on the situ. So that’s fun. Yeah. Let’s, let’s have fun. Okay. So the hot hand is the idea that it’s, it’s mostly used in sports. Okay. So let’s use the idea of basketball.

Somebody is, is watching a basketball game and, and one of their star players or their favorite players mm-hmm. , you know, hits three, three shots in a row real early in the game. So they run out and place a bet on that team winning because, oh, he’s hot, he’s hot. He, he can’t miss because he was hot for those..

five minutes. Bingo. And I, so I kind of set you up for that. But that’s, that’s the thing we, the gambler’s fallacy was a, is a belief. Well, the tend, the hot hand fallacy is this tendency to believe that a person has been recently successful at something. and the key as a person, we’ll continue that success.

It’s most applied and most studied in sports. How about horses such as basketball? It could, yes. Oh, horse, horse racing. You know, the, you know, because the horses won the last three races or whatever it runs Exactly. Runs well on on turf or Right, exactly. Likes mud, , whatever. So yeah, it’s applied most in investing in, in gambling.

after sports. Sports is probably the biggest. Right? So the, the key difference is that the gambler’s fallacy is the belief that a streak is due to change. Okay. And the hot hand fallacy is the belief that, that this streak is gonna continue. Do you see now how they’re Oh, closely related, but opposite? Yeah.

Okay. Got it. Got it. They’re both about streaks, they’re just different beliefs about the streak. Okay. And then the other difference is that the gambler’s fallacy, is mostly focused on probability of outcomes, like flipping a coin or the, the roulette wheel or Right. You know, dice, whatever. Whereas the hot hand is more often applied to a person, or as you said, you know, a horse.

Horse. Yeah. But, but mostly people for the dogs, you know, like, you know, who, whatever you like to give belong. So it’s, it’s the person who’s doing the winning. That’s the, the idea of the hot hand. Ah, I can remember talking to a Commodities broker who you know, asked him how he made his decisions. He said, well, I followed the hot hands.

And so now I kind of question how his results were. What I was gonna say there, there was actually a great study done. If you look at there’s a book called What Works on Wall Street, and there was a study done about mutual fund managers and if a mutual fund, you know, one of the things that they do is they look at the five year returns, right?

And a mutual fund manager, the, the, the top, let’s say three or four that have had the, the, the best five year returns. over. Don’t you want to bet against them? Ah, you wanna bet against them because that, that is going to end. So it’s again, a small sample. But doesn’t that go back to the, to the, the first thing about the gambling or well, the, this was a, a, a detailed study of their performance and after they’d had the majority, after they’d had that five year run, They done, they were done.

And their their next well, they couldn’t change their next few years. They’re, they’re thinking probably competitions changed. Yeah. Whatever. As y’all know, the market changes, right. As women sometimes the, the one kind of an exception. So there, there’s been a lot of research done about this. Mm-hmm. and Kahneman and Tversky.

Kahneman wasn’t part of it, but Tversky was that originally named. Yes. And, and they were the, you know, founders of the whole behavioral economics movement. Right. Or, or study. But they, in the case of someone where that has true talent mm-hmm. , then they can actually tip the odds a little bit. So it, it, it, it, so like a Mark Michael Jordan comes on.

He can, he. He could have done the whole thing. Right. The, the hot hand would be LeBron James, who would be less of a fallacy applied to one of those superstars. Okay. Got it. Okay. Rather than just pure dumb luck. Right. And this, this particular cognitive bias comes out of the group. You know, we’ve, we’ve got the three categories.

Mm-hmm. of. Too much information, not enough meaning, and not enough time. So this comes from the not enough meaning section and then the mm-hmm. The strategy that, that we apply to, to the, with these particular biases is that we fill in the gaps with either generalizations or generalities or stereotypes or just pure guessing.

So in this case, it, it, it’s taking a small amount of data and treating it like it’s a large amount of data. Oh, okay. I can understand. Okay. So you’re speculating. From here? Yeah. Here. Yeah. Like the three free throws. Right? Or in, in the case of picking stocks, if you see, you look at a stock and you say, Ooh, it was up yesterday and it’s up, it was up the day before that.

It’s had a three day streak. It’s on fire. I’m gonna buy it. Okay. It’s a very small sample. It doesn’t. , you know, there could, and that’s usually the kiss of down. And there’s a three day cycle in the, in the in case of stock, there’s a three day cycle from when somebody buys a stock to when they have to actually pay them, make sure the money’s in the account.

There’s, there’s a clearing, it’s called a clearing cycle. And so you know, a three day. You could have a, a piece of news and, and a, a buying flurry and then, you know it’s done right. So three days would be a lot different than three years in terms of what it means about the company. Right? Right.

Because when we buy stocks, we’re not betting on a horse race. It’s a company dominating in the marketplace. You know, it has people involved in it, . And so yes, it’s that idea of taking. Taking a small sample and extending it. And there are other cognitive biases that that, you know, we’ll cover in the future that, that also work with.

Stay tuned, misunderstanding, small samples. But so how to avoid this one, right? The, the way to avoid it is, Get more data, look at a, look at a larger sample size. Don’t assume that because something happened a couple of times, that that, that it, it means it’s a streak or that, that it has to continue. So yeah, we’ve had that too.

Anyway, this has been fun. Thank you for joining us for a few minutes on another cognitive bias, and we will see you in another venue. Tata.

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