Hacker News Reader

Comment by enoch_r | Hacker News Reader

> they are very likely to grow more slowly than average (i.e., revert to the mean)

I mostly agree with you, but this is basically the gambler's fallacy.

If I'm flipping a coin every second for days, and I hit a run of 10 heads in a row, "reversion to the mean" just means that the next 10 flips are likely to be less extreme than the previous 10. It does not mean that I should expect "more tails than usual" for the next flips. We revert towards the mean, not past it.

View on HN

No. The gambler's fallacy is when we ascribe dependency to independent events. Stock performance tomorrow is very much NOT independent of stock performance today, e.g. "market correction"

There is a pretty strong empirical support for the random walk hypothesis, the essence of which is that performance tomorrow is independent of performance today.

But shifts in the market aren't independent random events. You can definitely find examples of dramatic, real shifts in valuation but in the vast majority of cases business value is created over time. That rate of growth might be slightly faster or slightly slower, but you can be certain it's within reasonable bounds. So when speculation or scare drives the price higher or lower, you can be sure it will find its way back.

No, it's not like gambling.

Unlike in a casino, the returns and value of stocks are loosely coupled to the real economy.

If stock values grow quicker than the economy, then we should expect a correction, because of that loose coupling.

Of course, markets can stay irrational longer than we can stay solvent, so I wouldn't try to time it.

This is the definition of the gambler's fallacy. However, if you look at a chart of the stock market vs. a chart of a coin being flipped many times, they will look very different. While a coin being flipped will either asymptotically trend towards zero or a positive slope of .5 depending upon how it is charted, the stock market will have large peaks and valleys, meaning that after a period of high growth (overvaluation), the market will not continue to value these stocks at a steady growth of 10% per year. Instead, the market will correct the value of these stocks, which looks like a short term undervaluation and so we should expect "more tails than usual".

I recommend you look at the random walk hypothesis, the chart (not the average) of a coin flipped does not trend towards 0 and looks surprisingly similar to stock charts

It might appear that way but stock prices are actually tied to economic performance, not coin flips.

Reply on news.ycombinator.com