The fallacy of the maturity of chances has clear implications for traders.
Anyone who has traded for any length of time realizes that there are streaks of winning and losing trades.
After losing streaks, many traders are tempted to increase their position size, rationalizing that they are “due for a winning trade”, or cut back on positions sizes after a winning streak.
Unfortunately, the odds of any given trade being successful would be better estimated by the long-term success rate of similar trades in the past.
Conversely, there is no logical reason to decrease position size after a streak of winning trades.
This is assuming that traders continue to follow their trading plan, and don’t let the winning streak cause them to break their own trading rules because they’re feeling euphoric or that they can’t lose.
In addition, traders should have no reason to believe that their system is now more likely to underperform.
Obviously, if they believed that changes in market conditions or their own emotional state suggest that their method might be less successful, then reducing position size could be the prudent way to go.
The obvious difference between coin flipping and trading is that in coin flipping every outcome is randomly generated and so equally probable.
That is not at all the case in trading.
Even though we are frequently unable to discern the causes of price movements, their movements are rarely random, especially in longer periods in which fundamental forces have time to influence markets.
In addition, traders should have a consistent risk management and position-sizing strategy.
Risk Management: For binary options traders, who generally don’t need to plan profit taking or stop loss points, risk management is mostly a matter of choosing a low risk entry point near support.
Position Size: As with spot market trading, they shouldn’t risk more than a relatively small percentage of their overall account value. As noted many times before, regardless of the strategy you use, it’s important to be consistent despite winning or losing streaks.
The final way to minimize the impact of the fallacy of the maturity of chances on your own trading is the same as with any trader psychological issue.
A trader needs to be aware of the fallacy and that he must deal with it.
Remember, no matter how many times in a row the coin comes up heads, the chances of another heads on the next toss of the coin is still 50%.
Fallacy of the maturity of chances in trading!
Posted on by Rick Silva