Gambler’s fallacy arises because people misinterpret the averages, technically known as the “law of large numbers.” They think the low of large numbers applies to small samples as well as to large samples. This led Tversky and Kahneman (1997) to facetiously describe gambler’s fallacy as the “law of small numbers.”
Let’s go back to Farrell’s remarks about future returns. Notice that he tells us he is “pretty sure they will be below average.” Time will tell if he ultimately because in the twenty-one months that followed the Fortune magazine interview, the S&P 500 returned more than 41 percent. But his statement that he is “pretty sure” leads us the next issue---overconfidence.