Texas Sharpshooter Fallacy

The Texas Sharpshooter Fallacy is an analysis of outcomes out of context that can give the illusion of causation rather than attributing the outcomes to chance. The Texas Sharpshooter Fallacy fails to take randomness into account when determining cause and effect, instead emphasizing how outcomes are similar rather than how they are different.

The Texas Sharpshooter Fallacy, also called a clustering illusion, takes its name from a gunman who shoots at a side of a barn, only later to draw targets around a cluster of points that were hit. The gunman didn’t aim for the target specifically (instead aiming for the barn), but outsiders might believe that he meant to hit the target. The fallacy outlines how people can ignore randomness when determining whether results are meaningful. Investors may fall prey to the Texas sharpshooter fallacy when evaluating portfolio managers. By focusing on trades and strategies that a manager got right, the investor may inadvertently disregard what the manager didn’t do well. For example, the clients of a portfolio manager may have seen positive returns during an economic crisis, which may make the manager seem like someone who predicted the downturn.

Another example of the fallacy is an entrepreneur who creates many failed businesses along with a single successful one. The businessman touts his entrepreneurial capabilities while de-emphasizing the many failed attempts. This can give the false impression that the businessman was more successful than he really was.

The Texas Sharpshooter Fallacy is only one of many other fallacies a wise investor should understand and avoid. The Gambler’s, or Monte Carlo Fallacy occurs when someone bets on an outcome based on a previous event or a series of events. This fallacy derives from the fact that past events cannot alter the probability of future events. For example, an investor’s might make a decision to sell shares after a time of lucrative trading, thinking that the probability that the value will begin to decline is likelier after a period of high returns.

Investors also may fall prety to the Broken Window Fallacy, first expressed by French economist Frederic Bastiat. Bastiat described a boy breaking a window, for which his father will have to pay. Witnesses to this event believe the boy’s accident actually benefits their local economy, because the father paying the window repairman will, in turn, empower the repairman to spend, and will stimulate the economy. Bastiat points out the fallacy in such thinking by explaining that the father’s disposable income is reduced by having to pay for the expense, and that this is a maintenance cost, which doesn't stimulate production. In other words: destruction doesn’t pay.