Losers, Winners and Biased Trades

When aced with sequential information, consumers tend to fall prey to one
of two well-known heuristics; the hot(or cold) hand and the gambler's fallacy.
The authors relate these two traditionally seperate heuristics to differences in
accepting(buy) versus rejecting (selling) decisions. They identify trend length
as a contextual moderating variable and show an asymmetry between buying and
selling frames. When applied to a stock market context, a consistent finding is
that conumers prefer to buy past winners and sell past losers even when neither
should be preferred. This behaviour violates the normative rule of buy low and
sell high.
Gilovich found that viewers perceive a basketball player to have a better
chance of a basket after a string of successful baskets. Although the probability
of making a basket was not significantly different from the player's overall
average, viewers perceived a player to have a hot hand. Analogously, viewers
perceived a player with a tring of unseuccessful baskets to have a cold hand. The
hot (cold) hand phenomenon is analogous to overreaction and momentm investing in
behavioral finance. DeBondt and Thaler argue that consumers who rely on past
information become overly optimistic (pessimictic) about past winners (losers).
The hot (cold) hand would suggest that consumers infer that the future value of a
stock is greater(lower) when the sequence of past earnings shows an increasing
(decreasing) as opposed to a decreasing (increasing) trend. Hence, they would buy
stocks that show an increasing trend of earnings and sell stocks that show a
decreasing trend of earnings.
The hot hand fallacy seems to conflict with gambler's fallacy, which
occurs when consumers expect a reversal n a losing but essential random
sequence. The gambler's fallacy may be the underlying cause of Shefrin and
Statman's finding at the aggregate level and Odean's finding at the transaction
level that consumers hold on to losing stocks too long and sell winning stocks
too fast. In both cases, consumers expect a reversal in random events. Just like
the hopeful gambler, consumers hold on to losing stocks, expecting the string of
losses to reverse and let them recoup their losses.

Joseph Johnson; Gerard Tellis; Deborah J MacInnes
Journal of Consumer Research, September 2005; 32,2,ABI/INFORM Global
page:324

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