The Hindu Business Line : Gambler's fallacy

Picture yourself in a casino playing the roulette or any card game. You have already played four rounds and have, as expected, lost money on all occasions. What do you do?

The logical part of the brain tells you that having lost four consecutive rounds, the chances of your winning the next one is high. So, you bet your last chips at the table.

And, of course, you promptly lose the fifth round as well. What happened? Was luck working against you? Or was the dice loaded?

Psychologists have concluded that we expect events to reverse very soon. This behavioural bias is called gambler's fallacy.

How is this related to the market?

We typically expect a stock or the index to reverse after a move in one direction. Think about it.

Do you not actively look for stocks that are trading at their 52-week lows?

The fault lies in buying stocks just because they are trading at or near their 52-week lows or selling them because they are trading at or near their 52-week highs.

You should buy/sell such a stock after you get a confirmation that a reversal is, indeed, at play. Else, you will end up losing money just like a gambler in a casino.

(The author is Head, Research, Navia Markets.)

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