Have you recently thought about the Recency Bias?

We tend to associate more importance to recent events than we do to less recent ones.

The more vivid our memory of something which occurred in the past is, the more “available” that event will be in our mind and the more probable it will seem to happen again. But that’s not the right way to assess risk.

An event does not become more likely to recur merely because its last occurrence was recent, memorable, or still on-going—like the current bull market of ’08-’17.  Many people implicitly presume that the market would forever continue its gains (not talking about Singapore here), forgetting the fact that bear markets occasionally happened in the more distant past.

Our perception of history extends back only about ten years.  Blame that on our fading memory. This leads us to believe that government bonds are safe (mind you, a bond is just a promise, nothing more than that!). It further leads us to believe that the average recession is as bad as 2008’s, and that we’re in a new normal of high government debts and low interest rates.

That party might end soon. And it might not even require a Black Swan to spoil that party.

Looks like interest rates have been a bit higher in the past and the Easy Credit period lasted much longer. Careful with the cause and effect though!

Recency bias often “spoils” forecasts by those so-called “stock market experts”. These guys typically rely too heavily on the short-term past to forecast the long-term future. As such their “forecasts” should be more accurately called “postcasts.”

A bit of history

This bias is also related to “The Law of Small Numbers”, the tendency to exaggerate the degree to which a small sample resembles the population from which it is drawn.  By looking only at recent events, you reduce your assessment to a very small sample.

On the other extreme, there are the others with the “long view” who have looked further back and have studied the history of the stock market in minute details just to come up with the conclusion: “But this time it is different.”

In truth, it’s not only different this time, it’s different EVERY time.  History never repeats itself precisely.  Trying to predict the future by extrapolating the past is folly.  Despite this, humans are pattern seeking creatures and like to make forecasts based on patterns they feel they have discovered.

We tend to seek meaning from events, even if they are random.  Humans love to tell stories to themselves and to others about past successes being the result of skill, rather than luck, which only makes the “forecasting folly” problem worse.

Unfortunately, for those hoping for a different outcome favouring their hopes, dreams, or wishes, history is 100% consistent on certain broader matters: bubbles always burst.  And when they do, what people thought was fabulous wealth is proven illusory and it simply vanishes.

So always stay alert and take a quick look back into history now and then.

 

A bit of insurance

The probability that the recent trend will change is getting higher by minuscule steps every single day that trend continues.

I’ll go and buy some insurance. No, not the one from the common insurance peddler. The ones from option traders who are willing to sell me deep out-of-the-money Put Options.

Helps me to sleep soundly at night. Yes, I am getting old. With age I am just not that enthusiastic anymore about embarking on a roller coaster ride with my portfolio.

Hey, I am still a rational optimist. That’s exactly why the majority of my investments is in the stock market (= optimist) and I have insurance (= rational).

Now go ahead and let me know what your secret recipe for a sound sleep is in the comments below.

 

History happens twice because people don’t listen at the first time and in the rare case when they listen, they tend to forget unpleasant stuff quickly. – Some age-experienced guy

Leave a Reply

Your email address will not be published. Required fields are marked *