The gambler’s fallacy leads us to believe that something must change. So, when we toss a coin five times and it has a head then we believe that it has a higher probability to come trail in the next flip.
In real life, in the financial markets, and business, with the weather and your health, events are often interrelated. What has already happened influences what will happen. As comforting an idea as it is, there is simply no balancing force out there for independent events. ‘What goes around, comes around’ simply does not exist.
Business – When a business generates continuous loss then management thinks that now there is a chance of generating profit. But we have to think that it is not always possible to get profit from losses. If a business has generated losses in past then it has a higher probability to repeat the same further. Warren Buffett said, “turnarounds seldom turn.”
Investment – When we have seen a poor past fundamental performance of the company over a year but we believe that now the company will do well but it is not likely. We should understand that if the company has delivered a poor fundamental performance, then it has a higher probability to continue with it. There can be a very low probability to be come out as a winner. Rather to give higher weight to what can change, we should focus on what can remain as it is. We should write down points where things can sustain for a longer period.
This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.