Gambler’s Fallacy

Updated on May 23, 2024
Article byKatie Barton
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

Gambler’s Fallacy Definition

The gambler’s fallacy is a false belief that past events will influence future events – even if these events are independent of each other. It involves making incorrect assumptions about the probability of an event and ending up with wrong outcomes.

The gambler’s fallacy is also known as the Monte Carlo Fallacy. It is most often seen in gambling but can occur in everyday life. For example, investors and business people often make a gambler’s fallacy while making decisions, which may turn out to be poor judgment and result in losses.

Gambler's fallacy

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Key Takeaways

  • The gambler’s fallacy is the faulty belief that a specific set of sequences will lead to a particular outcome. It is most commonly seen in gambling but can also affect real-life decision-making.
  • The gambler’s fallacy is also known as the Monte Carlo fallacy, derived from the famous casino incident in 1913.
  • It is a cognitive bias that can lead to poor decision-making.
  • It is also closely related to the hot-hands fallacy.
  • Simply being aware of the gambler’s fallacy bias can help one avoid it.

How Does Gambler’s Fallacy Work?

Imagine that a person is flipping a coin. The coin has landed on the head side up five times in a row. How would the coin land on its sixth toss?

If the person chose tails only because the coin has already landed on heads five times, they have fallen victim to the gambler’s fallacy bias.

The truth is, the coin landing on heads five times has zero influence on which side it will land during the next toss. Therefore, regardless of its previous outcomes, the coin will always have a 50/50 chance of landing on heads.

A cognitive bias related to the gambler’s fallacy is called the hot-hand fallacy. It is a very similar concept that works in the opposite direction. If someone suffers from the hot-hand delusion, they believe that a winning streak will continue to win.

So, in the example above, if a person is subject to the hot-hand line of thinking, they would believe that the flipping would end up with the coin landing on heads since it already has so many times.

It’s not uncommon for people to fall victim to either of these fallacies. This is because our brains are hardwired to look for sequences and make assumptions from them. For example, a study appearing in the American Association for the Advancement of Science found that humans typically use three judgment methods in decision making. These methods are the availability of scenarios, representatives, and an anchor.

Although these judgment methods can be useful, they can lead to errors in decision-making. Some events are truly random – past sequences have zero effect on their future outcomes. They are independent of their previous nature and will continue to produce unpredictable results.

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Video Explanation of Gambler’s Fallacy

 

Examples

The most well-known case of gambler’s fallacy bias was observed in a casino in Las Vegas, from where this fallacy gained its name.

In August 1913, gamblers around the roulette table began to notice that the roulette ball had fallen on black several times in a row. Convinced that the ball would have to fall on red soon, many roulette players began to place their bets on red.

The ball didn’t fall on red until the 27th spin, costing the gamblers millions.

Because the roulette wheel ball had fallen on black so often, the gamblers thought the odds of it falling on red increased. This assumption was incorrect.

The actual probabilities of the ball landing on red were 50/50 for each spin. The number of times the ball fell on black had zero influence on the roulette ball’s next outcome.

Real-Life Examples

The gambler’s fallacy can affect everyday life. In everyday life, one can see the gambler’s fallacy occurring in luck or fear.

Here are a few beliefs that are classic cases of the gambler’s fallacy:

  • Lightning can’t strike the same place twice.
  • Assuming next year’s winter will be harsh because this year’s winter was mild.
  • Believing lucky or unlucky streaks has to end soon because one must balance luck.
  • Thinking the odds of a shark attacking in the same area twice are low.
  • A winning football team can’t continue its winning streak.

A fascinating gambler’s fallacy example is often seen in parents who believe that the gender of their first children will affect the gender of their next child. Even if a couple has five male children, it won’t improve the odds of their next child being female. The odds will always remain 50/50.

This fallacy can also affect decision-making in business. A 2019 study involving agricultural producers found that those who had experienced good outcomes the previous year were less likely to predict good results for the following year. These guesses were made solely on the producers thinking that their good luck must end. They did not make the decisions based on facts and data.

Since the share market is a scene of predictions an assumptions, gambler’s fallacy plays a frequent role in trading sessions. Traders and investors often fall prey to the gambler’s fallacy as they wrongly anticipate the opposite trend after the stock market follows a particular trend for some time. This may prompt them to make buying or selling decisions that can invite losses.

How to Avoid Gambler’s Fallacy?

The gambler’s fallacy is a cognitive bias. The good news is that merely being aware of the gambler’s fallacy and randomness can help one avoid falling victim to it.

It is better to stop and ask oneself this question when they are in a situation where the gambler’s fallacy may influence decisions.

Will past events influence future events, or does this situation happen randomly? Past events cannot influence future outcomes if the event occurs at random – such as a coin flip or roulette ball landing on a wheel.

If a person is on a winning streak, it does not mean that they are destined to lose next time. Likewise, if they are on a losing streak, they are not destined to win the next time. If something comes down to pure luck, one cannot accurately predict outcomes.

Frequently Ask Questions (FAQs)

What is the gambler’s fallacy?

Gambler’s fallacy is the false assumption that a chain of events that result in the same outcome tends to produce a different outcome in the next similar event. This is inaccurate because independent events always make unpredictable outcomes regardless of previous outcomes. A gambler’s fallacy example is the prediction that a coin-flipping can result in ‘heads’ after a series of flipping that resulted in ‘tails.’

How to avoid the gambler’s fallacy?

One can avoid the gambler’s fallacy by acknowledging the randomness of independent events and not letting the bias of optimism affect the decision-making.

What is a gambler’s fallacy in psychology?

Gambler’s fallacy is a cognitive bias produced from the brain’s natural tendency to seek out patterns and sequences. The human brain believes that a streak of good or bad luck would be met with the opposite result since the same result can’t linger longer. However, this has nothing to do with the true randomness of events, as any history of events does not influence its probability.

This has been a guide to the gambler’s fallacy and its definition. Here we explain the psychology of the gambler’s fallacy, along with real-life examples and how to avoid it. You may learn more about financing from the following articles –