People naturally look for patterns to make predictions and gain a sense of order. This makes sense in many aspects of life, but it can lead to huge mistakes in business!
If you flip a coin five times and each time it comes up tails, what do you bet will come up next? Do you guess the next time is more likely to be heads? If that's your answer, you'd fall for the gambler's fallacy. The gambler's fallacy is when people make predictions on what they see as a pattern, when actually no pattern exists. Every time you flip a coin, there's a 50/50 chance that it will be heads or tails. How many heads or tails have come up before don't change that.
However, people have lost money by betting a lot on lottery numbers that haven't come up in a long time because they believe the numbers are “due”. More seriously, this fallacy affects investors in the stock market. Investors will invest large amounts against the way a stock is currently going because they expect it eventually to turn their way, even though this does not logically make sense.
The fallacy affects professionals' judgment in non-financial decisions as well. For example, if a judge has been lenient in two cases in a row, he might feel he should be harsher on the third case to even things out. Bank workers are also more likely to reject a loan application if they've just accepted a few in a row. These people should base their decision on objective facts about each individual case, but they're subtly influenced by the fallacy.
How can you avoid being affected by this in your business or personal life? Being more aware of it can help. If you're interviewing potential employees and you've had one great candidate, don't expect the next one to be worse. Try to avoid the bias and have a clear reason for your decisions.
Would you fall for the gambler's fallacy?
How it can lead to bankruptcy
How it affects important decisions
Be more aware of it in your life
