Thanks to Of Dollars and Data for their blog post about this behavioral tic and an explanation for how it applies to investing. 

Answer: Exactly...50% [Coin flips are an independent process so the prior flips have no bearing on future flips]

Here's a short video explainer:

Questions:

• Why do you think that most people would expect the next coin flip to be Tails? 
• This phenomenon applies to other casino games, such as the Roulette Wheel (after 6 Reds in a row, the next one must be Black) and games involving dice. Does the Gambler's Fallacy hurt or help casinos? 
• When looking at a company’s stock price that has been rising for the past 2-3 years, do you immediately think…
  • This can’t last and it will likely fall OR
  • The price should keep going up? 

Click here for the ready-to-go slides for this Question of the Day that you can use in your classroom.

Behind the numbers (Of Dollars and Data):

Assuming the coin is fair (equal likelihood of heads and tails), you already know that the answer is 50%.  Because coin flips are an independent process, prior flips have no bearing on future flips.

But it doesn’t feel that way does it?  Even if you understand the basics of probability, after seeing five heads in a row, it can feel like a tails is “due” even though you know better.  This feeling is known as the gambler’s fallacy and explains why it is hard for humans to understand random processes.

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Here's how this might apply to investing where investors may see a streak such as the one below and decide to sell stocks because "the market is due for a reversal" (from Loring Ward):

Editor's Note: The returns for 2017 were 19.42%, 2018 finally went negative at -6.2% and 2019 had returns of 28.9%

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Check out our new Behavioral Finance mini-unit for additional lessons on the psychological and cognitive factors that impact our financial behaviors. 

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.