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

Also known as the Monte Carlo Fallacy, the Gambler's Fallacy occurs when an individual erroneously believes that a certain random event is less likely or more likely, given a previous event or a series of events. 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'

This line of thinking in a Gambler's Fallacy/Monte Carlo Fallacy represents an inaccurate understanding of probability. This concept can apply to investing. Some investors liquidate a position after it has gone up after a long series of trading sessions. They do so because they erroneously believe that because of the string of successive gains, the position is now much more likely to decline.

Example of the Gambler's Fallacy/Monte Carlo Fallacy

For example, consider a series of 10 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.

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. If before any coins were flipped a gambler were offered a chance to bet that 11 coin flips would result in 11 heads, the wise choice would be to turn it down because the probability of 11 coin flips resulting in 11 heads is extremely low. However, if offered the same bet with 10 flips having already produced 10 heads, the gambler would have a 50% chance of winning because the odds of the next one turning up heads is still 50%. The fallacy comes in believing that with 10 heads having already occurred, the 11th is now less likely.

RELATED TERMS
  1. Texas Sharpshooter Fallacy

    The Texas Sharpshooter Fallacy is an analysis of outcomes that ...
  2. Flip

    A flip generally refers to a dramatic directional change in the ...
  3. Trading Rut

    A trading rut is a period of investing during which a trader ...
  4. Martingale System

    The Martingale system is a system in which the dollar value of ...
  5. Inventory Flipping

    Inventory flipping is the act of selling a product or property ...
  6. Erroneous Trade

    An erroneous trade is a stock transaction that deviates so much ...
Related Articles
  1. Investing

    House Flippers Could Do More Good Than Harm

    The recent rise in house flipping transactions in the U.S. could very well be a good thing for the market.
  2. Personal Finance

    Are We On The Brink Of Housing Bubble 2.0?

    More than a third of houses flipped in the second quarter of 2017 were done so using finance.
  3. Insurance

    IPO Flippers And The Companies Who Hate Them (TWTR, ETSY)

    Learn how flipping activity affects an initial public offering.
  4. Investing

    5 Mental Mistakes That Affect Stock Analysts

    They know more about stocks than the average person, but analysts are still affected by biases. Find out what they are.
  5. Investing

    Multivariate Models: The Monte Carlo Analysis

    This decision-making tool integrates the idea that every decision has an impact on overall risk.
  6. Investing

    What Can The Monte Carlo Simulation Do For Your Portfolio?

    A Monte Carlo simulation allows analysts and advisors to convert investment chances into choices. The advantage of Monte Carlo is its ability to factor in a range of values for various inputs.
  7. Tech

    New Counterfeit-Proof £1 introduced by the British Royal Mint

    Dubbed "the most secure coin in the world", the new British £1 coin entered circulation March 28.
  8. Investing

    Flipping houses: Is it better than the buy-and-hold strategy?

    Real estate investors can choose flipping or buying and holding a property. Find out the pros and cons of each, and which real estate investment strategy may best for you.
  9. Insights

    Understand Your Motives Before Investing

    Those looking to get rich by investing should take heed of these motives before crafting an investment plan.
  10. Financial Advisor

    Don't Let Fear of Losing Keep You Out of Stocks

    Even if your odds of making money are 50/50, an occasional loss can convince you to avoid future risks. But often that loss heralds a good time to invest.
RELATED FAQS
  1. What is the broken window fallacy?

    Learn about the broken window fallacy. The broken window fallacy is a parable first used by French economist Frederic Bastiat ... Read Answer >>
  2. What is the difference between speculation and gambling?

    Learn about speculation and gambling, examples of speculation and gambling, and the main difference between a speculator ... Read Answer >>
Trading Center