Which of the following is an example of the gambler’s fallacy?

Shifting Fortunes and the Lure of Lucky Streaks

Jan 8, 2025

Have you ever seen someone at a casino slot machine certain that after ten losing pulls, the next must be a guaranteed win? This assumption—that a losing streak paves the way for victory—is a prime example of the gambler’s fallacy. The same error plagues stock traders who believe a beaten-down share suddenly “must” rise because it has fallen for several sessions in a row. Yet, such thinking often leads to poor choices. Markets move for reasons more complex than a simple reversion to the mean. Sometimes, poor earnings or changing industry conditions keep a share depressed for longer than one anticipates. And still, the temptation to believe that a losing run will magically flip can be irresistible.

Consider an imaginary investor, Alan, who enters a roaring bull market. He watches stocks climb day after day, marvelling at friends who boast of easy gains. As prices rise, Alan feels he has missed out. Then, a particular stock finally drops. Instead of reading the clues—perhaps an industry shift or negative announcements—Alan seizes on the idea that this losing streak must soon end. He buys, convinced the share cannot keep falling. Yet, the stock continues downward, crushed by massive selling, leaving Alan dismayed and out of pocket. He has fallen victim to the gambler’s fallacy: the belief that prior outcomes “owe” the next result.

While it is tempting to blame human nature for such blind spots, the issue goes deeper. This habit of expecting a reversal after a series of similar events sits at the heart of mass psychology and even influences large market swings through crowd behaviour. Fears of missing out, illusions of “hot streaks,” and a longing for quick wins converge to create attitudes that ripple through share prices. Rather than base decisions on thorough analysis or established signals, inexperienced traders place their hopes in a mythical “turn” that may not appear. The gambler’s fallacy appears harmless at a slot machine with a small budget, but it can wreak havoc on an investment portfolio if left unchecked.

Examining the Seeds of Misjudgement

Errors in judgment often creep in when emotions overshadow facts. The gambler’s fallacy stems from a flawed notion of probability, namely that independent events become entwined. For instance, in a fair coin toss, the odds of landing heads remain 50%, no matter how many times heads appeared beforehand. Translating this logic to markets is trickier, since share price moves are not always independent events. Yet, the gambler’s fallacy leads many to assume that a stock “must” rise after multiple plunges, ignoring relevant fundamentals or poor sentiment.

The dot-com crash around 2000 offers a telling example. In the late 1990s, tech shares climbed exponentially, helped by glowing press stories. Many everyday investors flocked to unprofitable start-ups, banking on the notion that “it cannot go down forever.” When the bubble burst, some strategists tried to catch the falling knives, believing a string of downward sessions had to turn at once. Regrettably, many stocks sank further, forcing latecomers to absorb severe losses. Rather than rely on rational signals—like balance sheets or the authenticity of the business model—traders fell for illusions around streaks.

Human biases do not stop at illusions of inevitability. Another miscalculation is recency bias, in which traders give too much weight to the most recent events. If shares slide for two weeks, many decide that the next month must bring a correction back upwards, even when either corporate earnings are weak or consumer trends have shifted. Combining the gambler’s fallacy with recency bias can be toxic; it lulls people into believing that a previous run of misfortune will yield guaranteed gains. Personal finances, pension pots, and entire trading accounts have evaporated on this flawed assumption. Genuine investing prowess depends on careful reading of business conditions and measured judgement, not a magical reversion to luck.

A reason these errors persist lies in our need for patterns. We hunt for stories and rhythms in random data, eager to discover links—even where none truly exist. Con artists thrive on this human longing by touting “guaranteed rebound” tips, luring gullible investors into traps. True mastery of market moves requires a separation of evidence from guesswork, a discipline that is easier said than done. The gambler’s fallacy seduces otherwise rational individuals into trusting that some cosmic scale must even out, regardless of any fundamental shift. The next sections will illustrate how these illusions shape broader market behaviour, including our responses during epic crashes.

Mass Psychology and the Wheel of Fortune

Share prices are shaped by human emotion as much as by profit statements. When crowds converge on a single belief—say, that a stock must bounce after consecutive dips—they create self-reinforcing moves. If enough buyers swarm in, the price might even show a temporary spike. The price action might seem to confirm their theory, spurring more buying. Yet, if the actual business is in decline, cold reality eventually prevails; the share cannot defy gravity for long. Thus, short-term bursts can mislead an unsuspecting crowd into believing they have found a winning strategy. The gambler’s fallacy meets mass psychology when entire groups adopt the same mistaken assumption.

Herd panic exacerbates the effect. Once a stock starts sliding, alarm can spread quickly. Bulging red figures on trading platforms ratchet up anxiety, prompting traders to dump shares at increasingly poor prices. Then, in a curious twist, the gambler’s fallacy can flip. Those harbouring the belief that “we have declined so much, we must be at a bottom” suddenly step in, hoping to capitalise on the wave of selling. Sometimes, they catch the right moment, especially if they have studied technical signals that hint at a potential floor. More often, newbies guessing that “it cannot go lower” meet disappointment when the price tumbles further.

This boom-bust pattern can be incredibly quick. In 2008, during the housing crisis, financial institutions appeared solid until they began revealing exposure to risky instruments. Share prices of major banks crashed. Plenty of speculators jumped in after a few days of declines, convinced that a mainstream bank “could not possibly get cheaper.” Subsequent losses proved devastating, illustrating how a mistaken assumption can prevail even as the broader picture disintegrates. The gambler’s fallacy whispers that luck must revert, ignoring the deeper structural flaws in the institution. The broader public, guided by frenzied media headlines and the momentum of the crowd, amplifies these manias and panics.

Behind the scenes, contrarian traders watch the herd’s reactions. They appreciate that if fundamentals remain questionable, a battered stock can keep falling. Sometimes, these traders use technical studies to gauge whether the selling might pause, but they seldom rely solely on the notion that multiple down days ensure an up day is around the corner. In doing so, they limit their exposure to catastrophic drops and wait for credible signs that the selling has reached exhaustion. That is the difference between a data-driven contrarian strategy and a gambler’s fallacy approach. True contrarians recognise that a losing streak has no automatic expiry unless something real has changed.

Behavioural Finance: Fear, Euphoria, and the Gambler’s Fallacy

A solid understanding of behavioural finance can shed further light on why the gambler’s fallacy pervades markets. Daniel Kahneman, in his famous work, showed that humans often rely on mental shortcuts that lead to systematic mistakes. One such shortcut is the assumption that because an event is overdue, it must happen next. Important to note is that financial events rarely adhere to simple probabilities akin to coin tosses. Real finances shift with external factors—consumer sentiment, regulatory changes, technological trends—yet the seeds of that fallacy remain. We search for simple patterns to comfort ourselves in the face of confusion.

Fear and euphoria are the twin motors that drive market players. When a run of bad news dominates the headlines, fear takes hold. The gambler’s fallacy might encourage certain individuals to fight that fear, snapping up beaten-down stocks simply because they assume fate must reverse. Meanwhile, euphoria pits the same bias in the opposite direction. If a stock soared for six days straight, eager traders may keep buying, insisting it cannot possibly lose tomorrow. Reality, however, pays no heed to prior streaks. A random corporate scandal or a shift in economic sentiment can break the pattern instantly, leaving dreamers in shock.

These errors gather scale when big crowds join in. On social media, stories spread fast. If a few influential voices repeat the gambler’s fallacy—“This thing has fallen five weeks in a row, so next month will see a climb”—others latch onto it without question. A swirl of excitement or dread forms, pushing the share price in exaggerated moves. The biggest winners often stand aside from these hype-driven surges, choosing to look instead at actual numbers or waiting for chart signals that suggest a genuine turnaround. Patience is a rare but precious ally in a market that oscillates between mania and despair.

Behavioural finance teaches that avoiding the gambler’s fallacy begins with mindful trading rules. One might decide in advance: “I will sell if the company posts a second quarter of declining sales,” rather than “I will sell if the stock goes down three days in a row.” The first method references tangible evidence, while the second clings to a purely statistical notion of streaks. The more we anchor our actions to real triggers rather than emotional narratives, the less likely we fall into the gambler’s trap of believing that random runs must turn on schedule.

Technical Analysis: Chart Patterns and Misleading Beliefs

On the surface, technical analysis might seem an ally of the gambler’s fallacy. Traders examine charts, searching for patterns such as “three day declines” or “five consecutive down candles.” However, a more mature application of technical analysis goes beyond counting streaks. It examines support and resistance zones, volume spikes, and trend lines. Rather than assume a downturn must flip simply because it has lasted for a certain stretch, skilled technicians look for signals that sellers are losing momentum or that large buyers are stepping back in.

For instance, a market participant might observe a share falling for five sessions. If volume diminishes on each session, that can hint that fewer sellers remain. A doji candle (where opening and closing prices are near each other) might suggest indecision, possibly indicating an upcoming reversal. That is distinct from the gambler’s fallacy. One bases a decision on actual data gleaned from trading activity, while the other pins hope on the notion that “this can’t keep going.” If daily volume roars higher, pushing the price even lower, the more likely outcome is a further slide—no matter how many red days have preceded it. Those who rely on evidence-based signals avoid the pitfall of equating streak length with an imminent reversal.

The gambler’s fallacy also appears in technical jargon. A misreading of the “law of averages” can creep into trading rooms, especially among novices. They might declare that after a stock evades certain breakdown levels, it is “certain” to snap back, ignoring that the next major piece of news could accelerate the decline. The solution is to combine technical signals with fundamental and psychological awareness. If the company’s business model has collapsed, no chart pattern alone can salvage it. By the same token, if a strong fundamental story collides with a temporary moment of despair, the chart may highlight a bargain entry point—but it is still wise to confirm that reason underpins the potential rebound.

Those who avoid the gambler’s fallacy incorporate tight risk management, setting stop-loss orders that acknowledge the possibility of continued downward motion. They do not blindly trust that an unlucky streak must end by tomorrow. Instead, they recognise that in markets, streaks can persist much longer than expected or can end without warning. In this way, the thoughtful use of technical analysis, grounded in rational evaluation, forms a bulwark against illusions about “deserved” reversals.

Lessons from Real Crashes: Dot-Com and 2008

The dot-com bust reminds us how mania can turn to misery in a blink. At its peak, traders repeated lines like “it has shot up all year, so it cannot drop now.” That is the gambler’s fallacy in euphoria form—the belief that a hot streak will keep rolling, or, if it stumbles, it will bounce back swiftly because “it always has before.” Once the bubble burst, investors leveraged the same fallacy in the opposite direction, concluding that “after so many losses, it must rebound.” Many lost their life savings on that assumption alone. Had they used thorough analysis—assessing real demand for new internet services or the actual finances of start-ups—they might have avoided ruin.

In 2008, countless thought that property could not lose value “all at once.” After years of ever-rising home prices, people believed a correction would be small or easily contained. When banks began to waver, speculators jumped in whenever shares dipped. Each small bounce led them to proclaim, “The bottom is in,” only for more revelations to drive the market even lower. The end result was a severe crash that hammered global finance. That painful lesson highlighted how streaks of declining prices can persist in ways that defy naive predictions of a quick snap-back.

On the flip side, certain contrarian investors thrived. They combined market knowledge with patience, waiting for signs that corporate earnings or credit markets were stabilising. They used technical signals, such as capitulation volume (when trading surges in a final wave of selling), to identify points with a solid chance of genuine reversal. Their approach was not “it must go up now,” but rather “the data suggest that forced sales are overwhelming rational sellers, so a bottom may be near.” By focusing on facts rather than the gambler’s fallacy, they avoided buying too soon and sold profitably into any short-lived relief rallies.

A final takeaway: true contrarians do not rely on luck. They weigh numbers, examine sentiment, and apply disciplined risk control. In the face of rash assumptions that streaks must end, they maintain clarity. Their success stems from rejecting the gambler’s approach and adapting to what the evidence indicates. This principle holds whether we are discussing a single stock or entire markets in panic mode. While some might yield to illusions about how events “should” unfold, seasoned players fix on tangible developments. That difference often separates those who survive a crash from those who lose everything, hoping for a quick turn of fate.

Closing Thoughts: Breaking the Spell of the Gambler’s Fallacy

In investing, wishful thinking can be expensive. The belief that repeated losses guarantee an imminent win is one of the most common traps that upend portfolios. A share may have plunged for legitimate reasons: poor leadership, disruptive competition, or simply an excess of hype. That share might stay lower for far longer than the gambler’s fallacy allows. Or a stock with multiple days of gains could abruptly reverse on unexpected news. Uptrends cannot roll on forever just because they have thus far. The gambler’s stance—assuming outcomes must even out—becomes a sure recipe for disappointment.

Yet, we do not have to remain prisoners of that illusion. Knowledge is power. By studying past events like the dot-com era or the 2008 meltdown, we grasp how easily illusions about streaks misguide even experienced market participants. By investigating real fundamentals—earnings, corporate strategies, industry trends—and mixing that perspective with technical signals, we gain a more reliable compass. When the crowd believes that repeated dips must cease or that an unstoppable run will never end, seasoned traders question these assumptions. They seek confirmation—volume changes, momentum shifts, real catalysts—rather than rely on luck to reverse the trend.

Above all, a steadfast mindset provides the greatest defence against illusions of probability. If you spot yourself or others uttering phrases like, “It has fallen all week, so it must pop up tomorrow,” step back and ask, “Why must it? What has changed?” This reflective approach might spare you from chasing a hollow bounce or clinging to a doomed enterprise. Instead, craft an approach grounded in facts, discipline, and an acceptance that markets do not care how many times a coin has landed heads or tails. They move according to supply, demand, and real-world forces—indifferent to our longing for pattern. In recognising that, you become an investor rather than a gambler.