Hot-hand fallacy
The hot-hand fallacy is a cognitive bias where individuals perceive a series of successes in a sequence of independent events as evidence of a 'hot streak.' Despite each event being random and independent of previous outcomes, people often believe that future success is more likely if one is 'on a roll.' This belief is prevalent in areas such as sports, gambling, and financial investing.
How it works
The hot-hand fallacy occurs when people misinterpret random sequences of outcomes, thinking that past successes increase the chances of future successes. This misconception arises because humans are adept at finding patterns, even in random events, and often attribute causality where there is none. The belief in the hot hand suggests that after several successes, a person is more likely to experience further success, despite each event being independent and having the same probability of occurrence.
Examples
- A basketball player who scores several consecutive shots will be perceived to have a 'hot hand,' leading teammates and spectators to expect continued successful performance.
- A gambler winning several rounds in roulette might believe they are getting 'lucky' and continue to bet heavily expecting the streak to continue.
- In day trading, an investor who makes several profitable trades in a row may be seen as having a 'hot streak,' attracting more investments based on perceived increased skill.
Consequences
Belief in the hot-hand fallacy can lead to overconfidence and poor decision-making. Athletes might overestimate their skills and take riskier shots, gamblers might wager more than prudent, and investors might hold on to overvalued stocks expecting continued success, all of which can lead to significant losses.
Counteracting
To counteract the hot-hand fallacy, individuals should develop an understanding of probability and statistics, emphasizing the independence of random events. Awareness of cognitive biases and adopting a more critical approach to evaluating patterns can help in reducing the impact of this fallacy.
Critiques
Recent studies have challenged the traditional view of the hot-hand fallacy, providing evidence that streaks may have some validity in specific contexts, such as sports, where skill can indeed influence outcomes. Critics argue that dismissing all streaks as fallacious overlooks situations where genuine factors can contribute to a series of successes.
Fields of Impact
Also known as
Relevant Research
The Hot Hand in Basketball: On the Misperception of Random Sequences.
Gilovich, T., Vallone, R., & Tversky, A. (1985)
Cognitive Psychology, 17(3), 295-314
Surprised by the Gambler’s and Hot Hand Fallacies? A Truth in the Law of Small Numbers.
Miller, H., & Sanjurjo, A. (2018)
Econometrica, 86(6), 2019-2047
‘Statistics: Learning in the Presence of Variation.’ The Mathematics Teacher, 92(4), 288-290
Wardrop, R. L. (1999)
Case Studies
Real-world examples showing how Hot-hand fallacy manifests in practice
Context
A mid-sized hedge fund employed a concentrated discretionary trader responsible for a sizeable portion of risk in a long-short equities strategy. Over several weeks the trader produced a sequence of above-average returns that outperformed the fund's benchmark and attracted positive attention from investors and internal leadership.
Situation
During a six-week period the trader posted profitable trades almost every day, delivering a 9% gain while the fund's overall portfolio was flat. Management, encouraged by the streak and short-term performance metrics, approved a 40% increase in the trader's position limits and temporarily relaxed daily risk checks to let momentum continue.
The Bias in Action
The trader and decision-makers interpreted the run of wins as evidence that the trader had discovered an informational edge and was 'on a roll.' They increased position sizes and kept adding correlated exposures rather than treating each new trade as an independent bet with its own risk characteristics. Routine risk controls were sidelined because the recent string of successes felt predictive. Statistical caution—such as testing whether the streak was consistent with random variation—was not pursued, and the team conflated short-term luck with durable skill.
Outcome
A single unexpected market shock reversed the positions: within three trading days the trader's books swung from a 9% profit to an 18% drawdown, producing margin calls that forced liquidations at poor prices. Investor confidence eroded, prompting a wave of redemptions and an internal review of risk governance.