Take a look at this picture. What do you see?

For the sake of argument, those dots represent the last three closing prices of a stock. The last three days the stock market was open, that’s the last price it sold at.

The exact stock ticker is not important. In fact, the exact price is not important either. What is important, though, is the trend – what those dots mean to you.

What do they say to you? What is happening to that stock?

The conventional wisdom might say that the stock is “going up” in price. That is, the idea that those three dots mean it is increasing in price – and it will keep going.

After all, the stock price increased every single day, and that in itself is a trend for those three days. That means it will keep going up in price. Right?

Well – not quite. One dot is higher than the next, but as statisticians would say – correlation is not causation. That Friday’s price is greater than Wednesdays will not cause next Tuesday’s price to rise. Yes, one is greater than the next, perhaps even by a certain amount – but that correlation between them in itself is not enough to actually perpetuate the effect in itself. They are not one and the same.

As human beings, our brain is sort of “hard wired” to see it as a trend. It creates the desire to act, the motivation to move, to spring to life. It is ingrained into us – and part of our internalized “fight or flight” response.

And that’s not necessarily a bad thing. Think about it: You are hiking in the woods with your family and see a bear in the distance. It turns around and spots you. And then, the bear takes three steps towards your family. Do you consider that a trend?

The three dots up above are three data points. But they only represent the past – not the future. The data has no bearing on what someone will sell the shares at tomorrow.

In The Intelligent Investor, Benjamin Graham said:

The speculative public is incorrigible. In financial terms it cannot count beyond three. It will buy anything at any price, if there seems to be some ‘action’ in progress. It will fall for any company identified with ‘franchising,’ computers, electronics, science, technology or what you have when the particular fashion is raging.

That’s a powerful statement. But it is not a jab at the average person. Rather, I think Mr. Graham was trying to explain something that is a hard-wired instinct.

Though you might jump or flee in the case of a bear, the three stock price changes are not indicative of anything else, really. That information is relatively meaningless in the grand scheme of things.

Stocks pop up and down in price all day long – some change price thousands of times per day. So before you jump at the next change in Google’s price – or anybody else’s, remember that Tuesday’s trades do not cause Wednesday’s performance – and three dots do not make a trend.

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