Polls / December 1, 2011

Do you know what the sporting term “hot hands” means and how it can relate to investing?

The term “hot hands” and how it relates to investing is known by almost a third of respondents to an eZonomics online poll.

She shoots – she shoots again
Is there such a thing as a lucky streak in sport or investing? A famous study about “hot hands” in basketball set out to test whether a basketballer’s chance of making a shot was related to whether the player made the shot before. Was there a lucky streak? Psychologists Tom Gilovich, Amos Tversky and Robert Vallone wrote that there was misperception of random sequences. Or, more simply, players thought they were more likely to get a shot if they got the one before – but their actual performance didn’t show this. The “hot hands” or lucky streak was only in the mind.
A Scientific American blogpost details further research into irrationality in sports. The question remains, how does this relate to investing?

Hotter and hotter
We know investors can be swayed by irrationalities such as overconfidence, herd behaviour and more. Perceptions – or misperceptions – of lucky streaks can also come into play.
The behavioural economics idea of the “gambler’s fallacy” is the idea that we have a tendency to think future probabilities are altered by past events, in a similar manner to those basketball players in the psychology study. A classic example involves a coin toss: if we have flipped heads ten times, we might think tails is more likely on the eleventh try. In reality, the probability of getting tails remains 50:50.

As an earlier eZonomics poll explained, an investor deciding whether to buy gold might become swept up by the idea of “hot hands” or lucky streaks and look to how the precious metal has performed in the past as a guide. Past performance can play a role but is not the be-all and end-all. As with shares and other investments, many factors influence the price of gold. The "hot hands" idea can serve as a warning to beware of using past rises as a guide to how a price will move in the future.

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eZonomics team
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