What Is the Gambler's Fallacy?
Let me explain the gambler's fallacy directly: it's the mistaken idea that past results in random events will influence what happens next, even though each event is completely independent. You see this a lot in gambling and investing, where people make predictions based on history that doesn't actually matter.
Key Takeaways
Understand that the gambler's fallacy leads you to think future random events depend on the past, but they're not. Past outcomes don't change future probabilities in independent events. Traders and investors commonly make this error by basing decisions on recent market moves. Remember the 1913 Monte Carlo casino event as a classic case. To steer clear, focus on your own research and ignore supposed patterns from history.
How the Gambler’s Fallacy Distorts Probability Perception
When events are truly independent and random, one outcome doesn't predict or affect the next. The gambler's fallacy tricks you into believing the next result will counterbalance previous ones, but that's ignoring the real independence and randomness involved.
Coin Flip Example of the Gambler's Fallacy
Take a series of 10 coin flips all landing heads. You might think tails is due next, but if it's a fair coin, the chance is still 50/50 each time. Every flip stands alone, so previous results don't impact what's coming. Betting on 11 heads in a row from the start is foolish due to low odds, but after 10 heads, the next one is still 50% heads. That's where the fallacy lies—assuming the streak makes heads less likely now.
Examples of the Gambler's Fallacy
In the famous 1913 Monte Carlo case, black came up 26 times straight on roulette, and people poured money into red thinking it was overdue—only to lose big when black kept rolling. This same thinking hits investing: after a stock rises multiple times, some sell expecting a drop, but that's not how probabilities work.
Frequently Asked Questions
You might wonder how far back this goes—Pierre-Simon Laplace described it over 200 years ago in his essay on probabilities. The cause? It's a behavioral flaw from assuming small samples represent the whole picture. To avoid it in trading, drop the idea that past events predict the future, stay current on data, track your trades, and seek feedback.
The Bottom Line
The gambler's fallacy fools you into thinking random events are connected when they're not, leading to bad calls in trading and investing. Recognize that each event is independent—past doesn't dictate future. Stick to solid research and your own strategies to make smarter choices and dodge this trap.
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