Gambler’s Fallacy

I discovered this today and realised that I too had fallen prey to this line of thinking. So, what is the Gambler’s Fallacy?

[…] 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, since past events do not change the probability that certain events will occur in the future.


Let’s take a really basic example, coin flipping. Assume we’ve flipped a (fair) coin 5 times and we got heads for all 5 flips. One might then predict that there is a high chance that the next flip will be tails. Unfortunately this is incorrect, and it’s exactly what the Gambler’s Fallacy is. The probability of a coin flip is 50/50 for heads and tails. This doesn’t change even if we’ve gotten 5, 10 or 50 heads in a row. It doesn’t make it any more likely for the next flip to be tails.

An application in the investing world, and a misconception that I once held, is that overvalued stocks are bound to drop in price. That’s just not true. Sometimes, overvalued stocks can stay overvalued for an unexpectedly long time. Just because it has been overvalued for awhile, it does not make it any more likely for a drop in price soon.

*cough* NASDAQ *cough*