Gambler’s Fallacy : Do you really have an edge?
Updated: Feb 15, 2022
The reason to get into any bet or trade is to take an advantage of the pay-outs because of the edge that you have. The edge could be a function of knowledge or skill. In sports, poker or trading, the side that wins in the long run is the one with Edge. In this blog, we try to showcase how two unseeingly opposite behavioral biases that are irrational and are a big source of profit for the gambling industry and brokerages.
Can one have edge in Coin toss?
If I asked you to bet INR 100 on a coin toss. And every time you win, I paid you Rs INR (INR 3 being commission) – Will you bet? The answer to this simple question is a clear NO, as you have no edge. Even the most compulsive gamblers know that this is a losing proposition and will stay away from this bet. However, if I tell you that heads occurred 8 out of 10 times in recent attempt. Would you now bet? Are thoughts of the coin being not fare racing your mind?
One of the most crowded tables in any casino is the roulette table. The roulette table is nothing but a coin toss with 37 outcomes (0-36) and you get paid only 36 times, in effect 1/37 being the casinos commission. A proposition which is equally worse to the coin toss with 97% pay-out. The reason people are betting on the roulette table is that because many people think that they can identify sequences. To nudge the gamblers, roulette tables display the last 20 numbers and Hot and Cold numbers (those being hit frequently and not) – a behavioral trick to trigger the delusions.
In a game of roulette, the ball has just landed on red seven times in a row. This leads you to believe that it will probably land on red again, so you increase your stake and bet on red. The false idea is that past events are somehow influencing current events. Even though, in the case of a roulette table, each spin is completely independent of the previous. Of course, the odds of getting red are exactly the same as black, just like in all of the previous spins.
Gamblers Fallacies are at play: Monte Carlo fallacy & Hot hand fallacy
Monte Carlo fallacy or its inverse the “Hot-hand” fallacy is a huge source of big profits for the gambling and betting industry. While, basic common sense says that a toss of a coin is a independent event and has nothing to do with previous events as the coin does not know it came heads before. However, when a string of results of independent events are presented, the irrational mind is quick in identifying sequences in it and forecasting the future with a higher degree of certainty.
Monte Carlo fallacy nickname was borne out of a particularly crazy night at a Monte Carlo Casino on August 18,1913 when the roulette ball fell into the black 26 times in a row. The probability of this happening is a staggering 1 in 136.8 million. Not even the most seasoned gamblers had ever seen a roulette wheel favor one outcome so heavily. This Monte Carlo casino raked in millions of Francs that night, thanks to the gambler’s fallacy. In fact, it was one of the most profitable nights of all time for any casino, as bettors kept betting on a reversal of outcome.
Hot-hand fallacy is derived from basketball where observers expected a high scorer to keep on scoring. A claim that players are more likely to make a successful shot if the previous shot was successful.
The Hot-hand fallacy occurs when gamblers think that a winning streak is more likely to continue. The belief is based on the idea that having already won a number of bets improves the probability that they will win the next bet or the next number of bets, too. Luck will continue favoring them as they are running hot.
Match fixing – Unintended consequences on betting
For every cricket match, betting sites like betfair.com and bet365 gives odds of a team winning the toss. Pay-out is generally 95% on this site for getting the toss right. As discussed earlier, there is no reason for anybody to bet on a toss without an even pay-out, as there is no edge. However, there are enough gamblers who bet on the same and the toss section is a very active market on the betting sites. But WHY? Other than the gamblers and hot hand fallacy there is one another key reason. It's fixed.
Two instances of toss fixing have been widely circulated:
These 2 instances, though debatable, are enough to fuel imaginations of gamblers and forecasting advice of insiders who claim to accurately give out tips on who will win the toss. Billions of dollars are wagered on sites on who will win the toss in cricket purely because they have been advised by a bookie or an insider. Or simply put the belief that the coin is not fair.
Fun Fact: Faf Du Plesis (Former South African cricket captain) has the record of losing 10 consecutive toss. Now if after the 7th toss loss by Faf du Plesis would you be willing to bet on the 8th toss of a win or a loss. Well the answer lies whether you believe in Hot hands streak or not. Faf du Plesis himself was convinced of his bad luck and for the 10th toss he brought his deputy Temba Buvama as proxy captain for the toss but still lost.
Do day traders really have an edge?
The stock markets see a lot of intraday volumes. With delivery volumes being only a fraction of traded volumes. These are basically people trading on an intraday basis on the basis of chart patterns. There is prospering industry of technical analysts giving intra day calls and Buy today Sell tomorrow (BTST) calls. There are multiple subscription services of such calls available and regularly given freely on business channels or telegram channels. Where does the edge come from?
Technical analysts are either believers in the hot hand fallacy. Trends and patterns are analyzed and stocks going up or down are expected to continue doing so.
Everything is fixed (Like Match fixing). Regular stock rigging scams convince traders that it is possible to make money by getting tips from insiders and being early into a stock manipulation trade.
The edge be it in sports betting or intra-day trading comes from insiders/fixers who seem to know more. But do they really? Well one can never say. However, the possibility of the edge has fueled the sports betting and intra-day trading industry.
About the Author
I have spent the last 15 years (2004-2019 ) as a Sell-side Equity Analyst covering sectors like Media, Telecom, and Consumer MidCaps. I was at SBI capital markets from 2004-2007 and at ICICI Securities from 2007-2019.
I was rated by Institutional Investor as the best analyst for Media – India for 2014-16. I am a Recreational Poker player and was the winner of the First ever WPT Indian Main event. I have dabbled a bit in Theatre. I wish I can watch more movies and read more books. Hope to travel around the globe.