The Trader’s Fallacy is one of the most familiar yet treacherous ways a Forex traders can go wrong. This is a huge pitfall when using any manual Forex trading system. Commonly called the « gambler’s fallacy » or « Monte Carlo fallacy » from gaming theory and also called the « maturity of chances fallacy ».
The Trader’s Fallacy is a powerful temptation that takes many different forms for the Forex trader. Any experienced gambler or Forex trader will recognize this feeling. It is that absolute conviction that because the roulette table has just had forex today 5 red wins in a row that the next spin is more likely to come up black. The way trader’s fallacy really sucks in a trader or gambler is when the trader starts believing that because the « table is ripe » for a black, the trader then also raises his bet to take advantage of the « increased odds » of success. This is a leap into the black hole of « negative expectancy » and a step down the road to « Trader’s Ruin ».
« Expectancy » is a technical statistics term for a relatively simple concept. For Forex traders it is basically whether or not any given trade or series of trades is likely to make a profit. Positive expectancy defined in its most simple form for Forex traders, is that on the average, over time and many trades, for any give Forex trading system there is a probability that you will make more money than you will lose.
« Traders Ruin » is the statistical certainty in gambling or the Forex market that the player with the larger bankroll is more likely to end up with ALL the money! Since the Forex market has a functionally infinite bankroll the mathematical certainty is that over time the Trader will inevitably lose all his money to the market, EVEN IF THE ODDS ARE IN THE TRADERS FAVOR! Luckily there are steps the Forex trader can take to prevent this! You can read my other articles on Positive Expectancy and Trader’s Ruin to get more information on these concepts.
Back To The Trader’s Fallacy
If some random or chaotic process, like a roll of dice, the flip of a coin, or the Forex market appears to depart from normal random behavior over a series of normal cycles — for example if a coin flip comes up 7 heads in a row – the gambler’s fallacy is that irresistible feeling that the next flip has a higher chance of coming up tails. In a truly random process, like a coin flip, the odds are always the same. In the case of the coin flip, even after 7 heads in a row, the chances that the next flip will come up heads again are still 50%. The gambler might win the next toss or he might lose, but the odds are still only 50-50.