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Loss aversion and streaks

Author Michael Shermer pens a column for Scientific American and has written several useful books on "skepticism" and science.

In his recent book (The Mind of the Market, 2008) on how evolution has shaped human economic behavior, we find the following passage:

Gamblers...are highly sensitive to losses, but not in the way you might think. They tend to follow a losing hand by placing bigger bets, and turn conservative after a winning hand by placing smaller bets. One rationale for this strategy is "double up to catch up"--no matter how many losses in a row, if you double the bet each time, you will get back all of your money when you eventually do win. But most gamblers tend to underestimate the number and length of losing streaks. ...More important, gamblers also tend to underestimate the number and length of winning streaks and lose out on the reward of placing larger bets during them. Of course, even with an optimal betting strategy that plays to win every hand, and keeping loss aversion in check, if you play long enough you will lose because of the slight edge to the house built into the rules of the game. But casinos make even more money than the house percentage would predict because of our loss aversion.

Discussion Questions

1. What do you think Shermer means here? Is it possible for players to detect when they are in the midst of "winning streaks" while playing randomly-determined games, and win more money as a result?

2. Do casinos win extra money from players who simply run out of funds before their luck can even out? Assuming each individual play has the same house edge and the bet amount is the same, would the casino care if one person placed a series of 100 bets rather than 100 people placing 1 at a time?

Submitted by Greg Bart