The Gambler's Fallacy

Has anybody applied The Gambler's Fallacy to trading?

Briefly what this says is "The gambler's fallacy is a logical fallacy involving the mistaken belief that past events will affect future events when dealing with random activities..." etc.

The idea is that the dice or roulette wheel does not have a memory. So if red came up 10 times in a row on the roulette table then the chance of it coming up red the next time is not affected by the previous results.

I am interested to know how this applies to trading.

Well generally in trading the theory is that one event DOES lead to another and so the results are not independent of each other.

Mark Douglas phrases it very well in his book Trading in the Zone when he says that the outcome of any single trade in a strategy is indeterminate but take as a whole over the long term will be profitable assuming that you have a profitable strategy to start with.

This kind of contradicts what I said in the first sentence but if you look at it as a series of trades of entry and exit points with targets and stops and perhaps varying contract sizes and scaling rules on each trade we end up with a system or strategy that will have a bias to winning over several trades.

There is actually an example of this in the wikipedia page:

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...the odds for drawing a jack, assuming that it was the first card drawn and that there are no jokers, have decreased from 4/52 (7.69%) to 3/51 (5.88%), while the odds for any other card have increased from 4/52 (7.69%) to 4/51 (7.84%). This is because the action (drawing the card) altered the state of the system (deck).

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Okay, here is another probability question:

Suppose you have 3 doors and behind one of those is a hidden treasure.

You pick door A and someone opens door B for you and reveals that there is no treasure behind door B. You are now given a chance to change your selection before the final door opening. Do you stick with your original choice (door A) or do you switch to door C?

What is your decision? And why did you decide that?

I have a poster in front of me and is written on it
"Plan your trade and trade your plan" any time i Devy from that I lost money......but sticking to it made money.....

Look at it this way: It does not matter how often you toss a coin, the next time it's still 50:50 a head or a tail. But that does assume a random outcome that does not really apply in trading where patterns really are likely. However, these patterns can also be assumed to be random in terms of predictability and probability. The outcome is dependent on what went before it in trading which is unlike a coin toss or dice roll.

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Originally posted by inventor

I have a poster in front of me and is written on it
"Plan your trade and trade your plan" any time i Devy from that I lost money......but sticking to it made money.....

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What is an example of when you deviated from the plan? For example, what did the plan say and what did you do?

that is a very good question to......I like to say hello to George Soros to I didn’t know he was with us still!.>>>>>>>>> First off I'm a 98% daytrader E-minis so when I get in a position and I get distracted, the minute I focus back on the screen and the trend goes against me, instead off getting oriented with my play I pull the trigger. The reason for that is I haven’t been able to honor the 1.75 point move.

What do you mean by "honor the 1.75 point move?" Waiting for it to go 1.75 points in profit or move back against you? How are you distracted when you are in a trade? I find that I end up reading emails or doing things on the internet when in fact I should be watching the trade and the charts.

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Originally posted by elite trader

What do you mean by "honor the 1.75 point move?" Waiting for it to go 1.75 points in profit or move back against you? How are you distracted when you are in a trade? I find that I end up reading emails or doing things on the internet when in fact I should be watching the trade and the charts.

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the second paragraph you are correct if you are trading concentrate at your trade 100% as far as the 1.75 points move it has been stated by some one in a book and has been observed by me that in a upside move there is a retracesmant of 1.75 points 80% of the time so if your on along position and it retraces 2 points you must pull the trigger less then 2 then there is still up side move.... this appry to ES so far.

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Originally posted by inventor

that is a very good question to......I like to say hello to George Soros to I didn’t know he was with us still!.>>>>>>>>>

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I hope I didn’t offend George with my remark I really meant to say he still watching this forum..!!!!!

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Originally posted by inventor

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Originally posted by inventor

that is a very good question to......I like to say hello to George Soros to I didn’t know he was with us still!.>>>>>>>>>

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I hope I didn’t offend George with my remark I really meant to say he still watching this forum..!!!!!

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No you did not offend me with your remark. Thank you for welcoming me back!

UrbanSound, you and I are saying the same thing. Simply using price bars you cannot predict the next bar. The predictability of future bars is in the patterns. Such patterns include S/R, Fibs and such. It is the formation that gives predictive value because from that you are able to see what other traders are thinking and hoping for.