The Trend Is Your Friend Till It Isn't

One time a very smart guy told me that the only stock he was really willing to make big bets on was Apple Inc. When I asked him why, he chuckled and said "It goes up!" That was in September 2012. The idea that a stock "goes up," like some law of nature, is an example of a very important behavioral bias: trend-following.

Trend-following, which has always been a puzzling phenomenon, has received some attention in the finance literature lately. Robin Greenwood and Andrei Shleifer looked at a large number of surveys of investors, and found that people's expectations of future returns are often just extrapolations of the recent past. Of course, those expectations usually turn out to be wrong, but people apparently believe them enough to bet on them -- when stocks go up and expectations soar along with them, money usually flows into equity mutual funds, only to lose out when stocks return to the long-term average, rather than the recent average.