Wednesday, March 17, 2010

The Gambler's Fallacy

It's more of a mathematical curiosity than anything else, but check out the odds of 14 successive up-days below, the record for which looks to get set by the SPY today. Less than one tenth of a percent ex-ante -- repricing or not, if that's not a pot of leprechaun gold for the bulls on this St. Pat's day, I don't know what is!

But what really stood out to me in this quick study, was the dramatic bullish bias shown this last year with over 60% of days ending higher as compared to 53% since the SPY's inception seventeen years ago in 1993. We've all seen it as green bars on our charts, but there it is documented in black and white.

This strong bullish bias significantly increases the odds of successive runs over a "fair" 50/50 flip of the coin. However, what are the independent odds of another up-day tomorrow? This is the "Gambler's Fallacy" -- looking forward it's just like day one all over again. Well, coins don't have any memory, do traders?

Notes: Observations are non-overlapping. For the curious, the previous record of 12 days, set in 1995, was followed by two mild down-days with new highs ensuing within five, and then a fairly range-bound trade for about a month-and-a-half before the market continued its ramp higher. Also see - July Flashbacks.

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