Experimental Study on Hot Hand Effect and Gambler's Fallacy of Chinese Investors

Abstract

With psychological experiments, we found that whenever stock price goes up or goes down continuously, gambler's fallacy will dominate hot-hand effect in investor's information process to serial changing stock price. When stock price goes up continuously, the longer the price up, the larger is the probability that investor think the price will drop down in next period, and the tendency to sell it get more evident. On the other hand, when stock price drops down continuously, the longer the price down, the larger is the probability that investor think the price will go up in next period, and the tendency to buy it became larger. These results suggest that at least psychological factor exist in the individual investor that hope the market will reverse to bullish in today's bearish Chinese stock market. Disposition effect is also found in the experiments, which is more evident in female investor than in male investor and more evident in the investor with low level investment knowledge and less experience than those with higher level. Experiments also indicate that Chinese investors like short-term investing which is much shorter than one year.

Keywords: hot hand effect, gambler's fallacy, psychological experiment, disposition effect