The Problem with Patterns

Do Market Patterns Continue?Almost every day, you can see something on the Internet or TV that says, “stocks decline for 3rd straight day” or, “stocks up for past 4 days”. The inference here is these 3 or 4 days constitute a pattern that is likely to continue. The reality is our brains often invent patterns to offer some sense of control over things that ostensibly are uncontrollable.

 

Illusory Pattern Perception

Ever “knock on wood” or avoid the 13th floor in a hotel? These are small actions that make us feel less helpless.  Scientists call this “illusory pattern perception”. The literature is replete with studies on how, when confronted with situations of uncertainty, individuals search for patterns even where they don’t actually exist.

So, what’s the danger? Well, if we simply extrapolate recent results, positive or negative, well into the future, we are apt to make poor decisions. We are fooling ourselves into believing that we can make future uncertainty less uncertain. We can’t.

 

Why We Seek Patterns

The constant search for patterns folds in nicely to some recent research on “time diversification” which finds (once again) that stocks actually are less risky than other assets over time in terms of accumulated wealth.  To some extent, the concept that we preach, “investing on purpose, for a purpose”,  is opposite the pattern seekers who always want to “do something” in their portfolios, even when the science says to cast your gaze towards longer term goals.

My belief is that we often look for patterns because we treat uncertainty as a proxy for risk. These are related concepts but not the same. The dynamic nature of markets do not provide certitude on a day-to-day basis. We have to be able and willing to accept that in order to lessen our risk for the long term.

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