3.3.6. Stock Pickers are Focused on Short Term

“The average long-term experience in investing is never surprising, but the short-term experience is always surprising,” - Charles D. Ellis - Winning the Loser’s Game.

The confusion of most investors is derived from their inability to look at large sets of data about stocks, times, managers or styles. Here is the reason for the confusion. With a small set of data, such as the 50 rolls of three dice shown in Figure 3-8, the assumption is that the chances of getting a six on the next roll was the best of all combinations. This poor representation of the long-term characteristics of the three dice is known as random drift, (in the casino they call it luck). This is similar to saying that an investor feels confident about a certain stock, time period, manager or style based on a recent short-term experience. In statistics, this is also known as a sampling error.

However, if one looks at the long-term or a thousand rolls of three dice in Figure 3-9 or 5 dice in Figure 3-9a, a far better representation of the risk and return characteristics is demonstrated, which reduces the confusion caused by sampling error, random drift, or luck. In Figure 3-9, it is evident that rolling a six is just as likely as rolling a 15 and a lot less likely than rolling a 10 or 11. The population characteristics for any large data set are best described by the average and the standard deviation, which represents the variance around the average. Investors, who think they see a pattern or trend in monthly or quarterly returns are experiencing random drift, just like 50 or 60 rolls of the dice. They are being fooled by randomness.

Figure 3-8	Figure 3-9