False Flags: How to spot misleading signals
Everyone hates making mistakes, but they are an unavoidable part of investing. No one can get it right every time. Incomplete information, changing circumstances or even just bad luck can result in expensive errors. But how about when the culprit is a false flag? These are decisions that feel totally justified at the time but turn out to be wrong.
In our special report, we look at how behavioural misjudgements make fund managers vulnerable to misleading signals.
Main takeaways
No penalty for speed: Faster decisions showed no loss in quality, meaning decisiveness grounded in process can be an advantage
Pressure sharpens focus: Decisions made during volatile periods tend to be more effective, challenging the belief that stress impairs judgement.
Perceived tail risk is a blind spot: Managers can misjudge risk and make costly errors during periods of heightened fear of extreme losses.
Process over outcome: Decisions made within a disciplined framework should be evaluated on their reasoning, not just their result.
How to define good decision-making?
Let’s start by acknowledging that every fund manager makes wrong calls. It’s an inherent part of investing. Professional investors are expected to take calculated risks based on incomplete information, volatile conditions, and evolving narratives. That’s why hit ratios tend to hover around 50%. This means even the best managers only get it right about half the time.
Eliminating mistakes is impossible, but good decision-making doesn’t mean making the correct calls every time – just often enough and when it counts. However, a crucial element is knowing if a decision is based on sound judgement and evidence, or due to an unidentified false flag.
What are false flags?
False flags are signals that appear rational and trustworthy at the time but ultimately lead to poor outcomes. What makes them dangerous is their ability to exploit our instinct to act quickly, protect gains, or respond inadequately to stress. Examples include rushing into decisions during volatility spikes and hesitating to exit poorly performing positions. Unfortunately, they don’t feel like mistakes until it’s too late.
How behavioural patterns influence decisions
We analysed behavioural biases linked to false flag decisions across 180 equity and fixed income portfolios. Our goal was to identify when (and why) experienced, successful investors made bad calls and how mistakes differ from momentary misjudgements.
We chose to focus on a few situations that frequently surfaced in financial discussions. These are ideas that are often mentioned but rarely tested:
Does acting too quickly lead to worse outcomes?
Are decisions made in volatile, noisy markets more likely to go wrong?
Does perceived tail risk impair decision quality?
Does acting too quickly lead to worse outcomes?
In an industry where timing is critical, how do we distinguish confident conviction from false urgency?
We examined decisions based on speed and found that they tended to be more successful when managers acted quickly. The speed of every investment decision was measured—defined as the time elapsed since the previous one—and then they were divided into quartiles. The fastest 25% were then compared with the slowest 25%, focusing on key behavioural metrics such as hit ratio and win/loss ratio.
One of our previous research documents had shown that delayed selling is widespread and can negatively affect performance. Therefore, we excluded them from this analysis; however, we still found that acting quickly doesn’t adversely affect success rates.
The findings were clear: acting quickly did not reduce the quality of decisions. If anything, fast actions were just as successful — and occasionally better — than slower ones. This suggests that speed, in itself, is not a sign of recklessness, but may instead reflect preparedness and conviction.
Are decisions made in volatile, noisy markets more likely to go wrong?
Investors are regularly warned against making emotional decisions based on increased market volatility.
When volatility rises, a familiar idea resurfaces: Time in the market beats timing the market. It means not overreacting to swings, staying the course, and avoiding making decisions in noisy markets. But does this wisdom hold up under scrutiny?
We looked at how managers actually perform when volatility spikes — and whether decisiveness under stress really leads to worse outcomes. Decisions were grouped based on the VIX index (a measure of volatility) at the time of execution, classifying conditions as calm, neutral, stressed or crisis. We found managers seemed to sharpen their thinking during periods of stress and make better decisions.
This illustrates that managers should be trusted with making decisions in high-stress environments – and not criticised if they don’t work out.
Does perceived tail risk impair decision quality?
We used the CBOE SKEW index, which measures perceived tail risk or the probability of extreme downside moves, as implied by the options market. Decisions were divided into three categories: low tail risk, normal, and elevated tail risk. Low and elevated backdrops were then compared.
Our findings revealed that decisions made during periods of high perceived talk risk performed worse than those in calmer periods. It may reflect the behavioural bias of miscalibration.
This is when fears of a crash dominate the narrative and can lead managers to act too conservatively, exit prematurely, or avoid opportunities that later prove profitable.
Conclusion
Investment mistakes can’t be ruled out entirely. Evidence suggests that even successful fund managers are only correct half the time. However, we can identify the mistakes that come about due to false flags, which are signals that appear rational but ultimately lead to poor outcomes.
False flags won’t disappear, but awareness is the first defence. Knowing how your own instincts can be hijacked separates good managers from the great.
About:
SkillMetrics® revolutionises investment expertise by providing advanced behavioural insights tailored for portfolio managers. Our cloud platform identifies strengths, weaknesses, and behavioural biases, leading to improved performance. CIOs/CEOs can coach teams to enhance results by focusing on the investment process. Fund Selectors benefit from skill monitoring and behavioural diversification.
SkillMetrics® gives investment teams a clearer lens on how to spot false flags and the behavioural biases that can make managers vulnerable. If you’re concerned about false flags influencing your decisions, let’s discuss.