What is the gambler’s fallacy? A lesson about probability.

The gambler’s fallacy is referring to probability and the wrong assumptions. It may lead to erroneous suppositions and bad trading decisions. You must always analyse the market very carefully and avoid any traps that are waiting for you on the chart or in your own mind. So what is the gambler’s fallacy?

The gambler’s fallacy

The gambler’s fallacy is the situation when someone mistakenly believes that something will happen or will not happen after a certain series of events. Why such reasoning is inaccurate? Because what happened in the past does not alter the probability of future events.

Let’s take an example.

Imagine you are flipping a coin. You got 20 “heads”. Now, in the gambler’s fallacy, you are sure the next one will most likely be “tail”. You are, nevertheless, wrong. Each coin flip is a stand-alone event and the probability of getting “tail” always remains at the level of 50%. The past performance does not change that.

The same case applies to slot machines. There are people who spend hours in front of the same machine because they believe each time they play they are closer to the jackpot. Again, this is not true. The probability of hitting a jackpot are the same for each game. It does not matter whether you have been playing 3 hours or 1 nor whether the jackpot was just hit or not.

Trading and the gambler’s fallacy

The phenomenon of the gambler’s fallacy is prone to occur in the trading world. Just imagine a situation where the market is going up for a really long time. Let’s say in 6 consecutive sessions the prices were increasing. Some traders may think that the most probable scenario is that it will decline throughout the next session. Or the opposite. When the market is falling in a series of sessions and traders are pretty sure it must go up next time. This is the gambler’s fallacy in action.

How to avoid the gambler’s fallacy

The very first thing you must understand is that each case is independent and does not rely on previous events. Even when the coin showed “heads” several times in a row, each time you flip the coin you have 50% chances for “head” and 50% for “tail”.

The same rule applies to the trading world. It does not matter how long the market was in the uptrend or the downtrend. The chances it will go up again are 50% and the chances it will fall are also 50%.

So what you can do besides understanding the gambler’s fallacy phenomenon?

You should never enter the trade based just on your feelings and beliefs. Instead, you ought to analyse the market profoundly. Read the economic calendar, stay up-to-date with the latest news that can affect the prices. Use the indicators that help to predict the future behaviour of the instrument. Rely on your knowledge and trading skills.

Conclusion

Trading always carries some portion of the risk. You should always be well prepared when you start the session. Learn about particular assets, get to know different indicators and different trading strategies.

Improve your skills by practising in the demo account which many brokers have in their offer. This is the account when you get virtual cash that can be replenished any time you want. Your money is safe and you can try different approaches and technical analysis tools.

Keep your trading journal in which you note all your past trades. You will have the opportunity to review the trades any time you need to and check what you did well and what was wrong. This will improve your trading performance in the future.

All this will help you to avoid the gambler’s fallacy appearance and make you a better trader.

Best of luck!