There are many dangerous cognitive/statistical cocktails, but surely one of the worst is made when we combine recency bias (the cognitive tendency to believe that the way things have recently been is the way they will continue indefinitely) with mean reversion (the statistical tendency for some price or performance measure to converge toward an average over time).
In times when market performance has been middling or poor, our tendency is to believe that’s what will continue happen going forward (recency bias), and this tendency–if we aren’t careful–can lead us to make jumpy decisions about how to be invested in the market, usually by wanting to pull back equity exposure haphazardly. But then, over time, market performance typically comes back up (mean reversion).
But the opposite can be just as dangerous! In times when the market–or, more often than not, a particular asset–has been going gangbusters recently, we tend to want to pile on after the fact, chasing above average returns, only to be bit when the mean reversion goes the other way.
This cocktail is what leads investors to perennially underperform their strategy, to buy high and sell low, and repeat drinkers are likely to experience long-lasting negative effects not on their livers, but on their overall financial and emotional well-being.
Meaningful Returns 