Definition
Gambler's Fallacy
The gambler's fallacy is the mistaken belief that past random outcomes change the odds of future ones — for example, that a stock 'must' rise because it has fallen several days in a row.
Markets in the short run are close to random, so a string of down days does not make an up day 'due', and a fund that has beaten the market for three years is not therefore certain to do so again. Believing in such patterns leads to averaging down into falling assets or doubling bets after losses, expecting a reversal that the odds do not promise.
A related error is the 'hot hand', where a recent winning streak is assumed to continue. Both stem from misreading randomness. Sound investing ignores short-term sequences and relies on long-term expected returns, diversification and a rules-based process.
Related terms
- Recency BiasRecency bias is the tendency to give too much weight to recent events and to assume the latest trend will continue, while ignoring longer history.
- Overconfidence BiasOverconfidence bias is the tendency to overestimate your own knowledge, skill or accuracy, leading to excessive trading and concentrated bets.
- Behavioral FinanceBehavioral finance is the field that studies how psychology and cognitive biases affect the financial decisions of investors and markets, departing from the assumption of perfectly rational actors.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.