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Fallacy of the Converse in Markets

Affirming the consequent is a formal logical fallacy committed even by professional hedge fund managers.

According to Wikipedia:

Affirming the consequent, sometimes called converse errorfallacy of the converse, or confusion of necessity and sufficiency, is a formal fallacy …

Converse errors are common in everyday thinking and communication and can result from, among other causes, communication issues, misconceptions about logic, and failure to consider other causes.

In the markets, this fallacy is frequently committed by retail traders using technical analysis in the following form:

Prices are rising (falling), so this chart pattern works

The formal fallacy arises because prices rising or falling has more than one possible antecedent. The market is too complex to describe with an implication of this form. I have some more details on this in Chapter 5 of my book Fooled By Technical Analysis. 

Unfortunately, this type of formal fallacy is also made by professional fund managers. Below is an example.

Prices are rising, so this time is different

If prices are rising, the affirmation of the consequent is a formal fallacy. This is because rising prices has more than one possible antecedent and it may not be the case that this time is different. It may be due to irrational exuberance due to excessive greed as before dot com bust.

Unless someone has received formal education in Logic, due to the high entropy of natural language it is often hard to spot informal fallacies and even serious formal fallacies such as an affirmation of the consequent.

Maybe passing a test in Logic 101 should be a prerequisite for managing OPM.

Logic is a hard subject with even counter-intuitive results. The more one studies Logic, the more evident its difficulty becomes. There is not just one system of Logic but many. I was lucky I had some very good teachers in college but I also took a few courses as electives although they weren’t required. In my opinion, at least Logic 101 should become a prerequisite for all disciplines.

This is a joke referring to the above:


Disclaimer:  No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.

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