Definition
Recency bias causes investors to extrapolate recent trends into the future—assuming rising markets will continue rising and falling markets will keep falling. After three years of bull market, investors increase equity allocations; after a crash, they flee to cash. This pro-cyclical behavior is the opposite of rational rebalancing and leads to buying high and selling low.
lightbulb Example
After the S&P 500 gained 25% in 2023, many investors projected similar returns for 2024 and loaded up on stocks. Historically, above-average years are often followed by mean-reversion, but recency bias causes extrapolation of the recent past.
verified_user Key Points
- Extrapolates recent trends into future expectations
- Pro-cyclical: buy after rallies, sell after crashes
- Opposite of rational mean-reversion behavior
- Amplifies market cycles and bubble formation