How A Logical Argument Can Improve Your Trading

Most trading methods can be categorized into 3 groups:

  1. Trading price action
  2. Trading technical indicators
  3. Trading fundamentals

These are by far the most popular, and they operate on logic-based principles.

But what does it mean to be logical anyway?

What ‘Logical’ Means

To begin, it’s important for us to first define what logical means, so there won’t be any misunderstandings later on.

Here’s a logical argument:

Premise 1: All birds are white

Premise 2: All swans are birds

Conclusion: (Therefore) All swans are white

This conclusion is logical because it follows the premises.

Here’s an argument that’s not logical:

Premise 1: All birds are white

Premise 2: All swans are birds

Conclusion: (Therefore) All swans are not white

This conclusion is not logical because it does not follow the premises.

So basically…

A logical conclusion is one that follows the premises.

Now here’s a logical argument, in the context of trading:

Premise 1: When the moving average indicator is moving down, market prices are likely to continue moving down soon after

Premise 2: The moving average indicator is moving down now

Conclusion: (Therefore) Market prices are likely to continue moving down soon after

Again, the conclusion here is logical, because it follows the premises.

Logic Doesn’t Mean Truth

I’m taking time here to explain what a logical conclusion means, because logic is often mistaken as truth.

There are logical conclusions that are true, and there are logical conclusions that aren’t true.

Here’s a logical conclusion that isn’t true:

Premise 1: All birds are green

Premise 2: All swans are birds

Conclusion: (Therefore) All swans are green

In this example, the conclusion is logical because it follows the premises.

However, the conclusion is obviously not true in reality.

In this way, there are many logical conclusions in the world that are simply not true.

How To Tell If A Logical Conclusion Is True

To test for truth in a logical conclusion, we’ll have to look at the truthfulness of the premises.

So with the green bird example (mentioned above), we know that although logical, the conclusion isn’t true because the first premise isn’t true (i.e. not all birds are green).

Whenever one (or both) of the premises isn’t true, the conclusion isn’t true.

Here’s an argument that’s both logical and true:

Premise 1: Some swans are black

Premise 2: All swans are birds

Conclusion: (Therefore) Some birds are black

This logical conclusion is true, because both premises are true.

OK Mr. Smarty Pants, But What Does This Have To Do With Trading?

Just bear with me… we’re almost there.

You see, in choosing a trading method, most traders follow some kind of logical argument.

Let’s revisit the moving average example:

Premise 1: When the moving average indicator is moving down, market prices are likely to continue moving down soon after

Premise 2: The moving average indicator is moving down now

Conclusion: (Therefore) Market prices are likely to continue moving down soon after

Essentially, this is the thought-process that traders go through when choosing a trading method – they observe what happened in the past and use that as a basis to predict where future market prices are likely to end up.

The Twist

Now here’s the interesting part…

Ready?

Here’s another logical argument:

Premise 1: No birds are blue

Premise 2: All swans are birds

Conclusion: (Therefore) No swans are blue

Did you notice something interesting here?

.

.

.

Did you notice that even though Premise 1 is not true (i.e. there are blue birds)…

… the conclusion is true?

What?!

But how can a false premise lead to a true conclusion?

Actually, it can.

There are plenty of false premises that lead to true conclusions.

Here’s another:

Premise 1: No animals can fly

Premise 2: All pigs are animals

Conclusion: (Therefore) No pigs can fly

Once again, we see how even though Premise 1 is false, the logical conclusion is true.

And The Point Is…

In a logical argument, true premises can only lead to true conclusions.

But not all true conclusions are formed by true premises.

This has big implications with regards to the effectiveness of how most traders choose a trading method.

Logic & Truth In Trading

So think about how you decided on your current trading method..

Is it based on a similar thought-process?

Premise 1: When [technical indicator] gives [signal A], market prices are likely to move up

Premise 2: [Technical indicator] is now giving [signal A]

Conclusion: (Therefore) Market prices are likely to move up

You now know that even if market prices do move up after signal A (i.e. the conclusion is true), it doesn’t necessarily mean that the premises are also true. In this example, Premise 2 is easy to prove but Premise 1 is a lot trickier – the only way to prove Premise 1 is to do a complete and objective statistical analysis of its claim.

Unfortunately, a retail trader like me does not have the tools, resources or expertise to carry out a thorough mathematical analysis of each new trading method I come across. Plus, I’m really just a lazy guy.

What I’d prefer to do instead, is understand the operating principles behind the trading methods I use.

To give a non-trading example: When people are hungrier than usual, they tend to overeat. If you’re the owner of a restaurant, you may do well to run your business with this principle in mind.

So here are a few questions I ask when evaluating a trading method:

Why and how does [trading method] work?

Would it continue to work in the future?

Under what circumstances would it not work?

Are the benefits of this trading method worth the cost of time/energy/risk it requires?

These are some questions that dig deeper into the core principles behind each trading approach.

Logic Is Not The Point, It’s A Tool

Logic is a tool we use to decide on a trading method. But as with all other tools, it has limitations.

And since we’re applying logic to our lives every day (as we do in trading), its important that we understand what these limitations are.

This post was not written to dismiss logic – rather, the point is to highlight the gaping loophole in the way traders choose their trading method, and to get them to think a little deeper about the core philosophy behind it.

“This trading method will work today, because it (sort of) worked before in the past” may be logical, but is a weak trading philosophy that will eventually manifest as poor trading performance.

So think about how you’re currently trading. How much of your trading method do you really understand? What’s the core philosophy that makes it work?

These are perhaps the real questions that traders should ask.

 

By |2018-11-05T04:29:26+00:00November 5th, 2018|Philosophy|19 Comments

19 Comments

  1. Don. Bennington May 10, 2012 at 8:26 am - Reply

    Hi Chris,
    An interesting post. I agree with what you are saying.
    Don

  2. Merrilyn Myers May 10, 2012 at 11:22 am - Reply

    Thank you for both the sharing of your lovely Bali photos and the logic article.

    I kept waiting for you to mention that the moving average is always a lagging indicator and therefore could very well be misleading as regards entry at market!

  3. Nicolas May 10, 2012 at 12:23 pm - Reply

    Hello Chris,

    I made much studies concerning the logic.
    Thank you for your interest in this domain

    Best regards

  4. Matt May 10, 2012 at 1:40 pm - Reply

    Hi Chris!

    Very interesting approach.I like philosophical ways of thinking combined with practical solutions. In that case, I agree that “pigs do not fly”, but I think that fact can not be equated with the market, which may be moved up or down or even not moving. In the market there are three options that affect the next assumption – up, down or side-way.
    Question as well as how to connect one of these three options by the following indicator that will fit our logical or illogical anticipate where the market will be moved … Maybe you have any ace up its sleeve that will resolve this dilemma.
    I hope so.

    Best regards!

    Matt

  5. Yarimawa May 10, 2012 at 5:22 pm - Reply

    Yes bros, I did reason with you. Thanks for the post.

  6. Frank May 10, 2012 at 6:43 pm - Reply

    Hi Chris
    Very interesting. Trying to be led by the past as the solution to the future is futile. I am referring to a Moving Average showing a downtrend based on the past information while the current candlesticks moves in an upward direction due to some announcements/statistics. No real logical decision can be made without proper facts. I cannot see that past forex average information can be of any use to a current situation which is so much different than the past and keeps on changing for future needs. I have not been in the forex trade for long but I have realized that indicators creates a lot of confusion and frustration. Some logical information which to use and how, and which not to use, could be very helpful – maybe in your next book/articles. Frank.

  7. Frank May 10, 2012 at 6:49 pm - Reply

    Hi Chris
    I forgot to mention, I enjoyed your Bali photos. Scenery is great and so are the beaches. It just looked very lonely with nobody on the beaches. Maybe that is what you ordered.
    Cheers. Frank

  8. Gordon May 10, 2012 at 9:39 pm - Reply

    Hi Chris,
    At least now, what were on my mind all this while seem to converge in. it’s also to do with how we human generally think! As one scrumbles to follow the market based on the past patterns( and believing the market is in his favour!), someone else (whose appetite is different) would have dealt his trade( which at that particular time was in his favour or otherwise),…leaving those left in the market in unexpected situations! (win or lose!) Hence, I believe trading methods may not work ALL the time. Its physcological responses and collective decisions of individuals that eventually move the market. People think differently with anxiety while trading!……..

    Gordon

  9. William May 10, 2012 at 10:28 pm - Reply

    Very insightful and Interesting Chris! Keep up the blog post!

  10. Dollie May 10, 2012 at 11:19 pm - Reply

    Thanks Chris for the insight. Being more logical might be good for my trading.

  11. Chris Lee May 11, 2012 at 1:19 am - Reply

    Hey guys, thanks for the comments.

    Although the moving average was used as an example here… the same concept applies across many other technical indicators.

    @Frank> To my surprise, the mosquitoes weren’t much of a problem… it’s the flies that were bugging me (pun intended) every time I sat down for a meal.

  12. Gina May 11, 2012 at 3:41 pm - Reply

    Yeah!
    And what the solution?

  13. jeffrey teow May 13, 2012 at 1:08 pm - Reply

    Hi Chris, very logical argument, if the premise is not correct, I agreed that all tradings will not be right.

  14. Frank May 15, 2012 at 11:44 am - Reply

    Hi Chris
    As long as the flies were not my e-mails, I am quite happy.

    • Chris Lee May 15, 2012 at 8:14 pm - Reply

      Haha… they’re definitely not!

  15. alfredo arcieri June 2, 2012 at 4:53 pm - Reply

    Good. Simple & Profound

  16. urysic July 29, 2012 at 1:36 am - Reply

    Well, I seem to be outside the concensus. There is a good reason that they say that the trend is your friend. If it was cold all last week, and it was cold yesterday. And it is cold today, lacking any other information I will bet on it being cold tomorrow. I will only be wrong at the turns. So, I know there is much to be gleaned from the past.

  17. Kevin (TDT) Harper March 12, 2015 at 4:38 am - Reply

    Hi Chris
    Great article as usual
    For me logic and past history are only a couple parts of a bunch of complex parts that have to come together (and made simpler “not simple”) to be able to trade successfully

  18. Jimmy Webb September 22, 2018 at 1:04 pm - Reply

    Very much agree with Author. very logical argument. Thanks

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