Small Sample Bias

Several months ago I said I was going to blog a series on trading biases and forgot to post more . . . . here's one that's very interesting : The most common is the small sample bias. Let's say you have 1 to 1000 odds you will come home every day with a dollar and once in a while you lose $1000. Many traders show very steady incomes but they could be fooling themselves because they don't have a long enough period of time to chart their performance. Their Sharpe ratio will not be indicative. In option trading, there is a similar bias. Short premium option traders, typically those who sell out-of-the-money options, are more likely to make money on a daily basis and then blow up. Likewise the yield hogs, those traders who would take any risk for a few basis points. You can fool yourself with your Sharpe ratios, and you can fool all of the financial engineers, but you can't fool an old Chicago trader who went bankrupt twice.