I love it when announcers say a player is due. For example, Adam Dunn, the prolific home run slugger of the Washington Nationals, has averaged a 4-bagger every 14 times at bat. Naturally then, if he goes 20 times at bat without a moonshot, the announcers will say he's "due" and viewers will edge a bit forward in their seats expecting this time at bat to be more likely than others to produce a shot over the wall.
This, of course, is "the gambler's fallacy" in disguise. The gambler sees 3 heads in a row and immediately announces that a tail is due and steps up to bet on a tail, as if the coin has a memory. The odds of a tail aren't, of course, affected by what came before just as Mr. Dunn's odds of hitting a home run aren't affected by the previous at bats.
In the world of investing, the gambler's fallacy causes investors to stay with losing positions too long. The voice in the back of their head says the stock is "due" to turn around. In fact, if they had a recent turn around situation, this can increase their perception that the odds of the stock going up have increased.
Awareness of "the gambler's fallacy" is a step in the right direction in improving investment performance. In fact, the best way to avoid the trap is to take a long-term perspective, invest in low cost index funds, and look at your portfolio less often. Instead, enjoy a ball game and root for Mr. Dunn and the Nats!
What gamblers are probably looking for is a "reversion to the mean"; there is no such law of course, and each toss of the coin (or die) is independent, but over the long run, it statistically should approximate 50/50 odds.
ReplyDeleteThis is all moot, of course, since the house takes a cut out of each toss ;)
Hi Kevin,
ReplyDeleteYou are exactly right. They are thinking of reversion to the mean. It's just an important example of how difficult it is to assess the odds in different situations.
Thanks for the comment.
DIY
I get that each flip of the coin is independent and that the cumulative odds should be 50/50 heads/tails. Also, I am certainly a believer in index investing. Although I do wonder how investors can deal with the emotions of the roller coaster ride we have been experiencing. Knowing that a strategy is best and feeling that a strategy is best can be two different things entirely.
ReplyDeleteI will be linking to your Google Insight post tomorrow in my Round Up.
Gambler's fallacy indeed Robert! Just one of many human inquiry flaws :)
ReplyDelete