Gambler’s fallacy: Why it matters in business?

Let me take you back to the roulette table of Monte Carlo casino in 1913.

In the last 10 spins of the roulette wheel, the ball has landed on black. The people in the casino thought it had been too long since the ball landed on red, and red was long overdue. As a result of this thought, they started betting against black. However, the same trend continued, and the ball was landing in a black. Simultaneously the betters were convinced that the ball would land on red in the next spin.

However, to their dismay, the ball continued to land on black not for 1o times, nor for 20, but 26 times. The wagers increased, and so did losses. The Monte Carlo casino had made a fortune on that evening in 1913.

This is an excellent example of gambler’s fallacy or Monte Carlo fallacy, as it got its name after the casino in Las Vegas, where it was observed in 1913. It is based on erroneous thinking that an event is more or less likely to happen due to previous events. Just like the gamblers/betters placed their bets thinking red was overdue and not based on any other reason.

Index:

What is the Gamblers Fallacy?

The Gambler’s fallacy is an erroneous belief of a person that past events or series of events can influence future events. This error occurs when a person mistakenly believes that a particular event is likely to happen or not happen based on the outcome of the previous series of events.

Thus, the fallacy manifests when a person believes a particular event in the past can influence future events. The fact that past events do not alter the probability of future events is the reason why this line o thinking and making decisions is flawed.

Why does the Gamblers Fallacy happen?

The gambler’s fallacy is based on a misjudgment that a series of events can conclude the outcome of the subsequent events. Gambler’s fallacy is an example of unsound reasoning. However, many people are influenced by this misjudgment, as they often underestimate the likelihood of happening or non-happening an event based on a streak of similar events occurring by chance. The Gambler’s fallacy manifests in two ways:

When an event occurs more frequently than usual, the probability of it happening in the future is less.
When an event occurs more frequently than usual, the probability of it occurring in the future is more.

It is the outcome of a cognitive bias where the happening or non-happening of an event is based on unrelated events and factors. The fallacy is rooted in our tendency to assume the occurrence of an event based on how many times it has occurred in the past. This tendency is due to many reasons, however; the most plausible reasons are:

Humans do not prefer randomness:

Something that applies to many humans is that we do not like randomness. As a result, we are drawn to rationalize everything, including random events. This way, we come up with an explanation for every random event and make them look predictable.

The tendency to make sense of random events:

Random events are called random because they are a product of chance. This is also the reason why they are unpredictable. However, since we humans are averse to randomness, we find unpredictability unsettling.

Humans are drawn to order, predictability and events, and things that can be explained. Therefore we seek patterns and connections between things and events that are not necessarily related to each other.

The tendency to think too few can represent many:

This tendency is highlighted in the “law of small numbers.” We tend to believe that small samples represent a larger share or sample. This is also regarded as “insensitivity to sample size,” which was showcased by Amos Tversky and Daniel Kahneman.

They also attributed this insensitivity to a representative heuristic where the mind creates mental shortcuts to make quick decisions. Similarly, we humans assume the likelihood of an event happening by assessing how many times a similar event has happened in our past.

Example of Gamblers Fallacy:

For example, assume that a coin has been tossed 5 times, and all tosses have resulted with tails side up. Under these circumstances, a person observing may assume that the next coin flip is likely to land heads side up.

However, it is a known fact that a legitimate coin has an equal chance of landing on either side and that no tosses are related to each other. Therefore by assuming the next toss to result in a head, the person is committing the gambler’s fallacy.

What are its effects? How does it impact business?

Gambler’s fallacy can not only affect people who visit casinos but also those who run businesses and otherwise. If we assess the probability of an event based on past events, we are all going to fall for the gambler’s fallacy.

Wastage of time and resources:

If we are a victim of the gambler’s fallacy, we tend to rationalize random events and data. This way, we are wasting precious time and resources on things that may not offer any solid outcome. This can be even more dangerous for new businesses and startups that have a comparatively low budget and limited resources.

Wrong decisions:

When we are busy rationalizing random events, we are not thinking straight. Moreover, by applying mental shortcuts and relying on chance to base our decisions on, we are likely to make a wrong decision. Our decisions are based on our judgments, and if we fall victim to the gambler’s fallacy, our judgment is prone to be erroneous.

Uninformed decisions:

Since the gambler’s fallacy makes us follow our hunch or base future events on past outcomes; we are not making an informed choice. Therefore by falling for the gambler’s fallacy, we are more likely to make uninformed decisions.

How can we avoid it?

To avoid the consequences of the gambler’s fallacy, we need to acknowledge and accept it in the first place. It is a cognitive bias and can be dealt with few steps.

We must understand that events can happen independently of each other. Therefore, it is not required for you to spend time drawing a link between two events.
We do not have to rationalize each and every event and piece of information. Sometimes things can be random, and finding a pattern or connection may simply cause a waste of time and resources.

Events may resemble each other, but it is not necessary that they may result in the same way. For example, the same marketing strategy for different products may lead to different outcomes.
Analyze and understand the situation accurately, and do not give unnecessary importance to superstition and chance.
When making a decision, seek help and suggestions from subject matter experts and unbiased parties to reach a decision.

A final word:

Humans and businesses alike are prone to the Gambler’s fallacy, and they must ensure that the key decision-makers are making sound and rational decisions. Think about the entire process and not just probable outcomes.

Just because the ball landed in black 26 times in the roulette wheel in 1913 doesn’t mean it will land in black every time.

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What is Gambler’s fallacy?

The Dunning-Kruger effect is a cognitive bias. The bias occurs when a person with limited knowledge, competence, or skills in a specific area, intellectual or social domain, overestimates their competence.

Whats the example of Gambler’s fallacy?

The Dunning-Kruger effect causes us to listen to people who speak first and loudest rather than people with reputations. This has a negative impact, as we accept advice from people who speak first rather than those whose words hold merit.