How the Gambler’s Fallacy Misleads Investors
People are wired to search for patterns, even in pure randomness.
What Is the Gambler’s Fallacy?
The Gambler’s Fallacy is the mistaken belief that after a series of similar outcomes, the opposite result is “overdue.” At a roulette table, it’s expecting black after several reds, ignoring that each spin is independent with unchanged odds. While financial markets are not fully random, this cognitive bias frequently appears in trading decisions.
How It Shows Up in Markets
Traders often interpret price or volatility streaks as evidence that a reversal is “due.” A common example is expecting a stock to rebound after consecutive down days.
In volatility markets, this bias is particularly prominent. Traders may buy volatility after extended calm, expecting a spike based purely on streak length, or short volatility after several days of elevation, assuming normalization is imminent. These behaviors overlook the reality of volatility clustering, where high volatility tends to follow high volatility, and low volatility tends to persist longer than expected.
Mitigating the Bias
Understanding the fallacy improves decision-making by encouraging traders to:
rely on empirical models and historical distributions rather than streak length,
distinguish true mean reversion from noise,
employ disciplined risk controls and position sizing,
and adopt probabilistic frameworks rather than narrative-driven assumptions.
Why the Gambler’s Fallacy Shows the Need to Allocate to CI Volatility
The prevalence of the Gambler’s Fallacy in investing underscores why many investors are better served by systematic frameworks rather than intuition-driven decision-making.
For investors susceptible to behavioral errors, allocating to a disciplined, rules-based volatility strategy like CI Volatility provides insulation from these cognitive pitfalls.