People often judge the future by what they’ve just seen. When a public official does something good that quickly gains attention online, many assume that they are honest or trustworthy simply because that one moment stood out.
But when a scandal emerges and dominates the headlines, people are just as quick to conclude the opposite. Psychologists call this mental shortcut the representativeness heuristic, which is the tendency to treat recent events as a reliable predictor of what comes next, even when the bigger picture tells a different story.
That tendency shows up everywhere, and in the stock market it can be very risky. Investors often believe that a recent performance is a reliable guide to the future. If a stock is rising, they assume it will keep climbing. If it’s falling, they expect the decline to continue. While this pattern feels intuitive, it often leads people to buy high, sell low, and miss the bigger picture.
Human judgment
Psychologists Daniel Kahneman and Amos Tversky, who both studied and taught at the Hebrew University of Jerusalem in the 1970s, explored this behavior in their groundbreaking research on human judgment.
In their studies, they introduced the idea of the representativeness heuristic, which shows how people tend to judge probability by similarity rather than actual statistics. Instead of weighing long-term averages or fundamentals, individuals often rely on how closely recent events fit a familiar pattern.
If a stock doubles in price within a few months, investors may see it as a ‘winner’ and expect it to continue its climb. On the other hand, if a company posts several quarters of losses, investors may conclude it is a ‘loser,’ even when the business fundamentals suggest recovery potential.
Mental shortcut
This mental shortcut ignores the reality that markets move in cycles and performance tends to even out over time. What investors often miss is that fundamentals, not short streaks, are what drive results in the long run.
For example, when the PSEi climbed close to 9,100 in early 2018, optimism was at a peak. Investors piled into blue chips like SM, Ayala, and Jollibee because they were convinced that their strong performance would continue.
But that optimism soon turned to disappointment. Rising inflation, higher interest rates, and global trade tensions quickly weighed on sentiment. Within months, the index slipped back, and many of the same stocks that had symbolized strength during the bull run lost significant value. Those who assumed the trend would go on indefinitely were caught off guard by how quickly the momentum changed.
A similar pattern also played out during the 2020 pandemic. When the PSEi plunged near to 4,000 in March 2020, fear gripped the market. Many investors assumed that the fall would continue without end and that the pandemic meant a prolonged collapse for the economy and the stock market.
Selling pressure intensified as people rushed to protect what was left of their capital. Yet within months, the index staged a sharp recovery. It rose above 6,000 by midyear and surprised those who had expected nothing but more losses.
Now, it’s important to note that momentum trading is not the same as representativeness bias, though they can look similar on the surface. Momentum buying and selling is a strategy built on discipline. Traders ride trends knowing winners can keep winning for a time and losers can keep losing. Think of it like surfing. You ride the wave while it’s strong, but you know it will eventually crash, so you prepare an exit.
Psychological trap
Representativeness bias is a psychological trap. Investors assume a rising stock will always rise, or a falling stock will always fall, without risk controls. They confuse short-term streaks with long-term certainty, which often leads to overpaying at peaks or panic-selling at bottoms.
Aside from recency bias that plays a big role, media coverage also adds fuel, with headlines like ‘PSE index rises for five straight days’ giving the impression that a temporary streak is the start of a lasting trend.
Social proof makes the bias even stronger. When friends share gains in Facebook groups or Viber chats, others assume the trend must be reliable.
And underlying it all is the tendency to believe that winners will keep winning, because that feels easier than taking the time to analyze company fundamentals and question whether the story really holds.
This tendency to take shortcuts may be common, but it is not impossible to avoid. The key is to always go back to the basics. Look at the fundamentals instead of chasing short streaks. Think in years, not weeks, because real performance plays out over the long run.
As Benjamin Graham would say, ‘In the short run the market acts like a voting machine, but in the long run it is a weighing machine.’ The danger of representativeness bias is mistaking today’s votes for tomorrow’s results.