A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

Biased Judgments
I meet investors every day who are convinced that they
can “control” their investment results. This is especially true
of chartists who are confident that they can define the future
by looking at past prices.
Larry Swedroe, in his 
Rational Investing in Irrational
Times
, provides a wonderful illustration of how hot streaks
occur with much greater frequency than people believe.
Each year a statistics professor begins her class by
asking each student to write down the sequential
outcome of a series of one hundred imaginary coin
tosses. One student, however, is chosen to flip a real
coin and chart the outcome. The professor then leaves
the room and returns in fifteen minutes with the
outcomes waiting for her on her desk. She tells the class
that she will identify the one real coin toss out of the
thirty submitted with just one guess. With great

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persistence she amazes the class by getting it correct.
How does she perform this seemingly magical act? She
knows that the report with the longest consecutive
streak of H (heads) or T (tails) is highly likely to be the
result of the real flip. The reason is that, when presented
with a question like which of the following sequences is
more 
likely 
to 
occur, 
HHHHHTTTTT 
or
HTHTHTHTHT, despite the fact that statistics show
that both sequences are equally likely to occur, the
majority of people select the latter “more random”
outcome. They thus tend to write imaginary sequences
that look much more like HHTTHTHTTT than
HHHTTTHHHH.
Aside from the long-term positive direction of the stock
market, streaks of excessively high stock returns do not
persist—they are typically followed by lower future returns.
There is reversion to the mean. Similarly, the laws of financial
gravity also operate in reverse. At least for the stock market
as a whole, what goes down eventually comes back up. Yet
each era’s conventional wisdom typically assumes that
unusually good markets will get better and unusually bad

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markets will get worse.
Psychologists have long identified a tendency for
individuals to be fooled by the illusion that they have some
control over situations where, in fact, none exists. In one
study, subjects were seated in front of a computer screen
divided by a horizontal line, with a ball fluctuating randomly
between two halves. The people were given a device to press
to move the ball upward, but they were warned that random
shocks would also influence the ball so that they did not have
complete control. Subjects were then asked to play a game
with the object of keeping the ball in the upper half of the
screen as long as possible. In one set of experiments, the
device was not even attached, so the players had absolutely
no control over the movements of the ball. Nevertheless,
when subjects were questioned after a period of playing the
game, they were convinced that they had a good deal of
control over the movement of the ball. (The only subjects not
under such an illusion turned out to be those who had been
clinically diagnosed with severe depression.)
In another experiment, an office lottery was conducted
with two identical sets of baseball cards. One set was placed
in a bin from which one card was to be selected by chance.

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The other set was distributed to the participants. Half the