"RED is SO DUE!" | Gambler's Fallacy

How this common misunderstanding can hurt your bottom line!

Ever been near a Roulette table and overheard (or said to yourself) “RED is so DUE, black has hit 10 times in a row!”  This is a classic example of the Gambler's Fallacy - a widely held but misunderstood concept about probability. When applied to investing, it can have serious implications. 

Misunderstanding probability can lead us down the wrong path in many areas of life, and trading/investing is no exception. 

Also known as the Monte Carlo Fallacy, this bias stems from the mistaken belief that if a particular event occurs more frequently than normal during a given period, it's less likely to happen in the future, or vice versa. This is a misconception because, in reality, each event is independent of the last.

In the world of investing, this bias can lead to perilous decisions. For instance, you might believe that a stock that's been on an upswing is "due" for a fall, or that after a bearish market streak, a bullish trend is around the corner. However, stock markets aren't coins that just flip. Their movements are driven by a myriad of factors like economic indicators, geopolitical events, and company performance. Simply put, what's happened in the past doesn't dictate what will happen in the future.

So, how can you avoid falling prey to the Gambler's Fallacy? Here are a some tips:

As always here, it’s best to attempt to Identify your biases and actively question your assumptions. If you find yourself thinking that something is "due" to happen, you could be succumbing to the Gambler's Fallacy.

Recognize that probability applies to random events and isn't influenced by previous outcomes. Each market day is a distinct event. Even each and every trade!

Make decisions based on research and a sound strategy, not on biases or gut feelings.  Your gut can be powerful in certain settings, but not without sound plans/reasoning. 

Stay informed about investing principles, market behavior, and cognitive biases. Resources like the 'Thinking, Fast and Slow' book by Daniel Kahneman, or the 'Behavioral Investor' podcast by Daniel Crosby, are excellent places to start.  I try to take in information every day, and not just charts/macro stuff.  I want to be more well rounded everywhere.  This all comes back to an improved bottom line.

The more you know yourself and the quicker you can stop and say “Whoa there’s that feeling, I know what that is!” The better investor you will be.  

Are you or someone you know grappling with the Gambler's Fallacy? Share this article with them and chat about it!

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Remember, KEEP YOUR SEAT AT THE TABLE!

Jaymes R.