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