There is a theorem in mathematics called the law of large numbers. Basically it says if you do something a whole heck of a lot of times, the probability of something will work out as expected. For example, if you roll a die 10,000 times, then average up the values, you’ll get very close to 3.5, as the possible values are 1 through 6.
But there is facetiously a ‘law of small numbers‘. What if you rolled a die 5 times and the total you rolled was 25? Then the average would be 5. Do you assume then that the average you roll with a 6 sided die is 5? That’s a silly idea.
But when it comes to investing, sometimes people do indeed believe in the law of small numbers. Based upon a hunch, they buy Apple on Monday and sell it on Tuesday and make a 2% profit. They repeat this 3 weeks in a row. Tada! They’ve discovered the secret to making money in the stock market. Buy Apple on Monday and sell it on Tuesday! This is where the law of small numbers can burn us. What is truly a coincidence looks real to us, because we have a very small data sample. This is exactly what happens to gamblers who suddenly think they have the magic formula for beating the casino.
Don’t let the law of small numbers fool you. Three wins or losses in a row do not determine your financial fate. Stick to the sound investment principals, even if you see temporary aberrations. The law of large numbers always beats the law of small numbers over time.