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The gambler’s fallacy is a widespread misperception of probability and randomness that can result in bad judgements. It also goes by other names, including the Monte Carlo fallacy, after a famous incident in 1913 at the Casino de Monte-Carlo, where gamblers gambled millions of francs because they believed that after the roulette wheel hit black multiple times in a row, it was more likely to hit red soon. This belief cost them millions of francs — because each spin is individual and the odds don’t change with the outcome of the prior spin.
What Is the Gambler’s Fallacy?
The gambler’s fallacy occurs when a person believes that if a random event occurs a sufficient number of times, the opposite is bound to occur soon. For example, if a coin lands on heads ten times in a row, a person may think that tails is now more likely on the 11th flip. But this is incorrect, because every flip of the coin is independent, and the probability of getting heads or tails is 50 per cent each time, no matter what has already happened.
The fallacy arises from a confusion about what randomness looks like. People tend to think that short sequences must “even out” to match the overall probability, but you can’t count on it with random things. Past independent events have no effect on future independent events.
Why Do People Fall for It?
The “belief in small numbers” largely drives the gambler’s fallacy. People idealize small samples, believing them to be exactly like the larger population. If you flip a coin 10 times and get heads every time, you might think that tails is “due” because it hasn’t appeared yet. But the fact is, small samples can be streaky and don’t necessarily reflect the true odds.
Our brains are also pattern-seekers, so we want to believe random events have an explainable cause, which means we also tend to think that random events are likely to “even out” in the short run.
The Monte Carlo Roulette Incident Example
In 1913, the ball at the Casino de Monte-Carlo landed on black 26 times in succession. So, believing — or rather hoping — that red was sure to hit next, they placed large bets on red. The ball finally landed on red, but only after 26 spins had elapsed and millions of francs had been squandered. The wagering odds were consistent the whole time — roughly 50/50 that the ball would land on red or black — and past spins had no effect on future ones.
This situation serves as an excellent example of the gambler’s fallacy and illustrates how it can lead to poor decisions due to misconceptions about probability.
How Does the Gambler’s Fallacy Apply to Investing and Business?
The gambler’s fallacy is not just a problem in casinos; it can also cause confusion for investors and business leaders. For example:
- Investors might believe a stock that has been falling for a while is “due” to go up or that a stock that has been rising will soon decline. This can result in poorly timed purchases or sales.
- For instance, sales teams may believe that after a slow period sales will pick up, or that at some point a good run of sales will end. This may lead to poor planning and resource inadequacies.
- After a streak of positive results, risk managers may underestimate the extent of risks, mistakenly believing that “bad luck” is unlikely to occur anytime soon.
The incorrect belief that past independent events influence future ones impacts choices in all these examples.
How to Escape the Gambler’s Fallacy
Avoiding such a fallacy requires a firm grasp of probability and randomness and a few practical strategies:
- Education and Awareness: Educate yourself about the gambler’s fallacy and spot it when it’s happening. It’s the first step toward not doing it.
- Adopt A Probabilistic Mindset: Worry about the real probability, not the perceived one. Know that independent events do not affect each other, and odds do not change based on previous results.
- Leverage Decision-Making Frameworks: Implement structured methods, like scenario planning, red teaming, or pre-mortem analysis to help you consider all possible outcomes and minimize cognitive bias.
- Seek Diverse Points of View: Seeking input from multiple individuals can challenge assumptions and lead to a greater clarity and understanding.
- Leverage Data and Technology: Employ data and analytics to recognize genuine patterns, not instincts or recency bias.
- Be Mindful and Self-reflect: Reflect on your judgement and decisions frequently to catch biased thinking in time.
Final Thoughts
I think the gambler’s fallacy is great example of the ways our brains try to make sense of randomness. We want to predict the future and feel in control of the unpredictable, so it’s easy to fall into this trap. But understanding that many events are genuinely independent and that past results don’t affect future chances is extremely important for making the best possible choices.
In investing or business, remaining loyal to a well-founded plan while not being swayed by the latest hot streak can help you avoid some expensive mistakes. I also believe that the best way to overcome this bias is to mix education with real-world tactics like data analysis and various feedback.
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Sources:
- www.forbes.com/sites/brycehoffman/2024/08/27/the-gamblers-fallacy-what-it-is-and-how-to-overcome-it/
- www.investopedia.com/terms/g/gamblersfallacy.asp
- www.investopedia.com/recency-availability-bias-5206686
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