CORRELATION / CASUALITY

Let's consider a young investor who has primarily allocated their portfolio to technology stocks during a prolonged economic expansion. During this period, the technology sector has experienced exponential growth, driven by disruptive innovations and a climate of strong investor optimism.

Investor's Misconception: The investor attributes their significant gains solely to their analytical skills and stock selection abilities. They might claim to have anticipated market trends, identifying companies with high growth potential.

Critical Analysis:

• Market Effect: In reality, the exceptional performance of the portfolio is largely attributable to the favorable macroeconomic context and the overall upward trend of the stock market. The growth of the technology sector has been supported by a combination of factors, including low-interest rates, accommodative monetary policies, and an increase in demand for digital goods and services.

• Selection Risk: Although the investor has selected successful stocks, it is difficult to say with certainty that their choice was determined by rigorous fundamental analysis rather than a simple factor of luck. In a rapidly growing market, many stocks tend to follow the general trend, making it difficult to distinguish between performance due to a wise choice and performance due to simply being invested in an expanding sector.

• Cognitive Biases: The investor may be a victim of cognitive biases such as the representativeness heuristic (the tendency to judge the probability of an event based on its similarity to a prototype) and confirmation bias (the tendency to seek information that confirms one's pre-existing beliefs). These biases can lead them to overestimate their own abilities and underestimate the role of luck in their success.

Conclusions: The example illustrates how, in a particularly favorable market environment, it is easy to confuse one's investment skill with the effect of the market. It is essential for investors to be aware of the cognitive biases that can influence their decisions and to adopt a disciplined, data-driven approach to evaluating their performance.

• Exponential growth: Rapidly increasing growth

• Disruptive innovations: New technologies that significantly disrupt existing markets

• Macroeconomic context: The overall economic environment

• Accommodative monetary policies: Policies aimed at stimulating economic growth

• Fundamental analysis: Analyzing a company's financial performance

• Representativeness heuristic: A mental shortcut that helps us make quick judgments

• Confirmation bias: The tendency to seek out information that supports our beliefs