The Gambler's Fallacy in Trading Forex

Trading in the forex market means learning how to take and manage risk, and this process has quite a bit in common with successful gambling methods as well as gambling pitfalls.

As a result, forex traders can benefit from understanding some key theoretical ideas that have been developed to improve gambling techniques.

A concept that has some relation to trading in the forex market is often called the Gambler's Fallacy, but it is also known as the Monte Carlo Fallacy or the maturity of chances fallacy.

The Gambler's Fallacy Explained

Gamblers who lose out from operating under this fallacy tend to hold the false belief that repeated but independent tests of what is essentially a random process will even or average out over time.

Their thinking falsely infers that any notable deviations from random observations will eventually be met by roughly equivalent deviations in the opposite direction.

A classic example of this fallacy is when a gambler thinks that if a set of coin tosses all come up heads, then a toss of tails will probably follow in future iterations.

Nevertheless, since each toss of the coin is statistically independent from every other toss, the chances of the toss coming out heads versus tails remains even on each subsequent toss for a fairly constructed coin.

Equally fallacious would be the idea that subsequent fair coin tosses would be more likely to come out heads.

How the Gambler's Fallacy Comes Up When Trading Forex

The rough forex market equivalent to the above gambler operating under the Gambler's Fallacy would be the forex trader who thinks that just because the market has gone up for the last few days, that it should subsequently go down for a similar period.

As a result of observing intraday exchange rate fluctuations or perhaps by reading about some simplifying assumptions made by economists, they might mistakenly think that rate movements seen in the forex market are completely random.

Nevertheless, the fact remains that notable and prolonged trends are often observed in the forex market. This trending phenomenon can arise as the economies and monetary policies associated with the currencies involved in a particular pair are manipulated by governments and central banks.

As a result, trading forex based on the Gambler's Fallacy can be a costly endeavor.

Overcoming the Gambler's Fallacy When Trading Forex

One method that can help traders overcome the mental tendency toward having their trading account succumb to the Gambler's Fallacy involves incorporating some flexibility into their trading style.

For example, this might take the form of changing their trading strategy based on an objective set of criteria in order to adapt to the irregular shifts in the forex market between what can best be characterized as trending or directional and ranging or non-directional markets.

Another useful and time tested way to avoid common psychological betting pitfalls like the Gambler's Fallacy is to first come up with an objective forex trade plan that shows consistently profitable results and then develop the discipline needed to stick to it.