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B. Venkatesh

YOU have a list of stocks that have risen sharply in the past six months. You find that the delivery-to-traded-quantity (DTQ) ratio for these stocks has also risen during this period. Will you immediately conclude that a stock would go up if the DTQ ratio increases? If you do, you may be suffering from clustering illusions. What is this?

It refers to the human tendency to draw patterns from random events. Suppose the stock market closed lower on Fridays during the last 10 weeks. You may conclude that the market is likely to decline the coming Friday. But that may be a random event.

Clustering illusions occur in all walks of life. A classic study in this area is the paper `The hot hand in basketball: On the misperception of random sequences'. The study tested the widely held belief that basketball players have "hot" and "cold" streaks.

The popular belief is that if a player nets the ball in successive occasions, he will continue to do so through the game. Likewise, if he misses the basket, chances are he will continue to do so. The study found that players netting the basket was governed by chance. The "hot hand" hypothesis is just an illusion.

The Texas Sharpshooter Fallacy is a closely related concept. It derives its name from a Texan who fires his gun randomly at the side of a barn. He then paints a bulls-eye around the spot where the most bullet holes cluster.

This fallacy is used to describe clustering illusions in epidemiology, a branch of medicine that studies transmission and control of disease. A city suffers from a certain disease. The city also houses industrial units of a certain kind. Experts immediately conclude that the industrial units cause the disease. Find any similarity with your conclusion on the DTQ ratio?

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