The fallacy of logical reasoning


When I was young, I used to take pride in my ability to reason out things. In my ability to think logically.

I was rather good at determining the cause and effect. In deducing one thing from another. Not your regular Sherlock Holmes, but good enough.

I suffered from no delusions of being smart, but at the same time, I knew I possessed the rather uncommon commodity, that rather ironically went by the name of Common Sense.

Then I grew older.

During my PhD years, research (and a rather brilliant advisor) made me realize that just common sense is not enough. You needed another arrow in your quiver.

The ability to think differently. To think outside the box. Luckily, that came pretty easily too.

I had it all figured out. In order to succeed, you mostly needed the ability to think logically and that little bit ability to think outside the box.

Pretty simple, ain’t it?

Then I grew older.

High school taught me the importance of thinking logically. Grad school, the importance of thinking outside the box. And investing is now teaching me that my definition of logical thinking was all wrong.

At least, what I defined as logical thinking.

Google the term “Logical Reasoning” and this is what you get.

Logical reasoning tests (also known as critical reasoning tests) are designed to assess a candidate’s ability at skills such as how to interpret patterns, number sequences or the relationships between shapes.

I know that this is the definition of logical reasoning tests, but for the purpose of our discussion, it will do just fine. We can infer what generally goes for logical reasoning.

And this is exactly what I also thought is meant by logical reasoning.

I am now beginning to realize how wrong I was.

Much of what passes as logical deduction is nothing but hindsight bias — being wise after the event. Assigning causes with the benefit of hindsight. A grossly wrong overestimate of our ability to make rational decisions.

Let me give you an example.

We are in the year 2020. Stock markets have fallen 40% in the last three years. It turns out that the markets had peaked on September 14, 2017.

The months preceding the top were marked by markets making new highs almost on a daily basis, volatility reaching historically low levels, FED signaling its intentions to turn off the tap on easy money and hot tech IPOs. It had been almost a decade since the last recession.

And here we are in 2020, with markets having suffered a 40% fall since those days. Its obvious what you should have done then.

You should have sold your stocks. It was so obvious. The writing was on the wall. There were warning signs all over the place.

Come back to the present. All the signals mentioned above are very much in place. Does this mean you are going to sell your stocks today?

Of course not!!

What happened??

The trick is that all these signals seemed so obvious and logical only when I told you that the markets made a top in September 2017 and have fallen 40% since.

In fact, if I had told you the markets had risen 40% since September 2017, your brain would have come up with equally logical and obvious reasons to why you should have bought more stocks in months preceding July 2017!

And the amazing part is that all the reasons that you can come up with, both for the fall and rise of the markets, are all correct!

That’s just the way our mind works! Trying to deduce the “obvious” after the event and then expecting the same to happen again is the default state of our mind. It requires effort on our part to stop making these so called obvious and logical conclusions.

These days I find myself saying “I don’t know” a lot more often. I guess I better get used to it.