Gambler's Fallacy/Monte Carlo Fallacy

What is the 'Gambler's Fallacy/Monte Carlo Fallacy'

The gambler's fallacy is when an individual erroneously believes that the onset of a certain random event is less likely to happen following an event or a series of events. Also know as Monte Carlo Fallacy. This line of thinking is incorrect because past events do not change the probability that certain events will occur in the future.

BREAKING DOWN 'Gambler's Fallacy/Monte Carlo Fallacy'

For example, consider a series of 20 coin flips that have all landed with the "heads" side up. Under the gambler's fallacy, a person might predict that the next coin flip is more likely to land with the "tails" side up.

This line of thinking represents an inaccurate understanding of probability because the likelihood of a fair coin turning up heads is always 50%. Each coin flip is an independent event, which means that any and all previous flips have no bearing on future flips.

This can be extended to investing as some investors believe that they should liquidate a position after it has gone up in a series of subsequent trading session because they don't believe that the position is likely to continue going up.