How The Gambler’s Fallacy Impacts Investor Psychology
- January 27, 2021
- Posted by: Kirsten Campbell
- Category: Blog
Gambling and investing are very different in practice, but there’s a distinct overlap with regards to the psychological and emotional forces at work. Being human sets us up to be biased, whether we acknowledge it or not. We are well-documented emotional decision-makers—even when we’re picking stocks or betting on sports.
In fact, the $85B global sports betting market is where we commonly witness the gambler’s fallacy at play. It often appears as the belief that when LeBron sinks the ball three times in a row, he must be ‘on a roll’ to land that fourth shot. Wrong! The gambler’s fallacy is to perceive patterns where none exist. We may believe that LeBron is playing especially well in a game and that he can’t miss, but probability disagrees. It can only be 50%—a free throw can’t remember the last shot.
Choose your fighter: Independence or randomness
While placing bets, gamblers can often forget about the existence of independent probability and erroneously believe intangible patterns might be at work. We see investors make the same mistake when they prioritize gut feelings and their personal ‘strategies’, over data and facts, while curating their own portfolios. Smart investors are made savvy by balancing their emotions with cold hard facts.
Dependent probability is often present at the card table—assuming no card is placed back in the deck. Removing a card from the deck changes the outcome of the next card that can be pulled. We see the gambler’s fallacy occur when a player has perhaps won two rounds in a row, so others bet against them, convinced that they’re out of luck and won’t win for a third time.
To thine own self be true
Judges, bankers and even umpires encounter the gambler’s fallacy on any given day, and must be mindful while navigating the psychological pitfalls. Investors can be particularly susceptible to personal bias and attribute weight to ‘logic’ and ‘patterns’ that simply may not exist. Remember, investors are people, and people are emotional decision-makers. Astute investors understand this, and will go further towards mitigating their worst money impulses (which we all have) and avoid falling into psychological traps like the gambler’s fallacy.
Here are two tips we’ve learned that may help keep your eye on the prize:
- Remind yourself to look at every investment like LeBron’s free throws—independent and unrelated.
- Realize that no one has yet demonstrated the ability to predict randomness, much less an investor. So the inner voice guiding you to the ‘right’ stock without demonstrable data, might be very misguided. Stop, take a deep breath and re-read #1.
Many investors—with and without the benefit of experience—treat investing like gambling. Understanding investor psychology can have a powerful effect on your portfolio, and your wallet will likely thank you over the long haul. And remember, there’s no substitute for educating yourself with the necessary knowledge to make informed and practical financial decisions.
Although we never offer any investment advice, if you’re curious to learn more about investing in and via equity crowdfunding, check out TruCrowd’s online investment portal
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