American mathematician Jordan Ellenberg shares a cautionary tale about the "Baltimore stockbroker" to illustrate the dangers of mistaking luck for expertise in investing.
Imagine receiving an email from an investment fund: "Partner with us - we always pick winning stocks. To prove it, here's a free tip: buy shares of Somebody Inc." The next day, Somebody Inc.'s stock soars.
The following day, another email arrives: "Sell shares of Whatever Holdings." Sure enough, Whatever Holdings' stock plummets the next day.
This pattern continues for ten days, with the fund's predictions correct every time. On the eleventh day, they write: "Convinced yet? Ready to invest?" Having seen ten consecutive accurate calls, you think it's a sure bet. You pour your children's college savings into their recommended stocks.
Here's the catch: the fund sent 10000 emails. Half (5000) recommended buying Somebody Inc., while the other half advised selling. When Somebody Inc.'s stock rose, they followed up with the 5000 recipients of the "buy" advice, splitting them again: 2500 were told to buy Whatever Holdings and 2500 to sell. If Whatever Holdings' stock fell, they contacted the 2500 who received the "sell" advice, and so on. After ten rounds, roughly ten people received ten consecutive correct predictions. Convinced of the fund's brilliance, these ten hand over their savings - only for the fund to vanish. This tactic mirrors how TV illusionist Derren Brown accurately predicted five winning horses, then persuaded a young mother to bet her life savings on a sixth.
In reality, such scams may be rare. Ellenberg noted on X that he's unaware of a real-world Baltimore stockbroker case, though chance alone could produce similar outcomes. With thousands of investment funds operating, some achieve remarkable returns, drawing attention and heaps of investment. But does this reflect market genius or mere luck, while other funds quietly fail?
Consider this: if 1296 people in colorful hats roll dice, about 216 will roll a six. If those 216 roll again, roughly 36 will get another six. If those 36 roll again, about six will score yet another six. If those six roll once more, one might roll a fourth six. Now, notice that winner's orange-and-black-striped hat and claim it's the secret to rolling four sixes in a row.
Success is easy to rationalize after the fact, but we should focus on factors that predict future success. There's no evidence that the person in the orange-and-black-striped hat will roll a six again. In investing, distinguishing luck from skill is critical to making informed decisions.