The Monte Carlo Casino Incident (1913)
One famous historical event illustrating the gambler’s fallacy is the story of the Monte Carlo Casino incident in 1913. At the roulette table, the ball landed on black 26 times in a row, defying the 1-in-66 odds. Gamblers at the casino started believing that red was “due” to come up. As a result, they began placing large bets on red, expecting the streak to end. However, the ball landed on black again, causing significant financial losses for those who fell victim to the gambler’s fallacy.
The Gambler’s Fallacy
The gambler’s fallacy affects everyone, from the most novice traders to the most experienced ones. It’s a very prominent pattern in trading, as you are put in a position where you can study everything beforehand. You are given a sense of control over your decisions with your knowledge of charts, price action, candles, triangles, patterns, and every other trading fundamental you have acquired. However, this comes at a price.
You find yourself in a position where you believe you cannot lose. After winning consecutive times, you are overflowing with pride — pride in the fact that you are a winning trader, which compels you to continue even when you eventually lose.
What happens when you lose? Your emotions take over. Emotions that go from euphoria down to a vengeful state where you have to make everything back. You start questioning probabilities and numbers, even beginning to throw them away and disregard them. Each time you lose, you become even more determined to win it all back.
I already won consecutive times, surely I’ll win again.
We’ve all been in this position—a lucky day, a winning trade, a quick flip with maximum returns. It may have happened to you multiple times in one day or even in a span of a few hours. The euphoria is unmatched, and your pride is at an all-time high (along with your portfolio, even). The feeling of invincibility sets in, and it seems like you can do no wrong at that time. So, you go on and continue, knowing that you haven’t lost yet.
You get cocky and confident with hot hands that haven’t failed you. It looks like luck and your fundamentals are with you today, but then, one flick, one trade, and you lose everything you’ve won. Again, and again.
I’ve already lost consecutive times, surely I’ll win this next one.
How many times can you lose, right? One more time should do the trick. One more trade should offset your losses, and you can restart the whole situation. You start again, putting everything you know and channeling whatever amount of luck you’re riding on, putting in the trade that will be your winning one.
But you lose. Again.
That doesn’t stop you, and you move forward with another trade with the same mindset but even more intense emotions than the last stop. Guess what? It happened again.
How do you get back? How do you remember that you are a trader, not a gambler?
1. Understand Probability and Randomness:
Acknowledge that markets are often driven by random and unpredictable factors and that each trade is independent of previous ones. Patterns may work in trading but there will be times that blindly relying on these patterns can be your undoing.
2. Develop and Stick to your Plan:
Stick to a well-thought-out trading plan based on your risk tolerance, investment goals, and market analysis. These are factors that will help keep you level headed in times of high euphoria or in situations of constant losses. Do not deviate from these factors just because of short term wins and loses.
3. Don’t just boast about your fundamentals, use them too:
You have your fundamentals and you’re proud of them right? Well, you know you can use them too. Base your decisions on a combination of technical analysis and fundamental analysis. Numbers and patterns will often win over emotions. Fundamentals keep you on track with your objectives. Avoid making decisions solely based on recent market trends or historical price movements.
4. Have a Target and Keep it Clear:
Establish proper targets, goals and even scenarios where you have to stop. Stick with them and do not let previous wins or losses affect these goals. A small calculated step towards a target is often more successful than a big emotional swing at an unsure victory.
5. You’re not Invincible and you are always at Risk:
Implement risk management techniques, such as setting a fixed percentage of your portfolio for each trade. Adjust position sizes based on your risk tolerance and the volatility of the market. Like I said, you know your fundamentals, put them to use.
6. The Past is a Present too:
Regularly review your trades, whether they were profitable or not. You need to understand why you took a trade, why you took that win and why you took that loss. Learn from both successes and failures to refine your strategy and develop your own trading thesis further.
7. Question Others:
Seek advice from experienced traders. You are not the best at this (yet). Ask what other think of the trade, how they see the numbers. A different perspective can put you back in the proper place and in the proper mindset. Having a second opinion can help you avoid tunnel vision and emotional biases.
8. Be a machine. No emotions required:
Emotions can cloud judgment. Be aware of your emotional state and try to make decisions based on logic and analysis rather than fear or greed.
You have to remember that not everything in the space is a guaranteed win and how volatile everything more here, you will be met with unexpected losses from time to time, which is enough to take away everything if you’re not careful and if you’re not mindful.
You are not a gambler. You do not follow your emotions. You do not say “one more time”.
You are a trader. You follow your fundamentals and you know when you stop. A trader wins in any kind of market because they do not gamble.
