Logical Fallacies In The Financial Media

According to the aptly named logicalfallacies.info, a logical fallacy is, quite simply, an error of reasoning.  Logical fallacies abound in everyday life:  everybody from college professors to politicians, businessmen, and scientists unknowingly commit these errors of reasoning on a daily basis.  The financial media is not exempt from this.  Following are logical errors the financial media in particular is most prone to making.

Post Hoc Fallacy

The full latin term “post hoc ergo propter hoc” literally means “after this therefore because of this.”  Commission of this particular logical fallacy in the financial media is quite common and usually takes the form of “the Dow fell today on higher oil prices” or “the market rose on low inflation.”  While at first glance it may indeed seem logical that higher gas prices would put downward pressure on the Dow, it’s far from a foregone conclusion.  It is entirely possible for both oil to go up and the Dow to go down.  Similarly, just because the Dow just happened to go down on the same day oil went up doesn’t mean one caused the other.  In most cases, day-to-day fluctuations of the stock market are statististically meaningless and don’t require an external explanation.  It’s just noise.  Of course, that’s not to say the market wasn’t actually down on higher oil prices, but there is simply no way to know that for sure.  But financial journalists would be out of a job if they simply told the truth.  Imagine tomorrow’s headling:  “market fluctuations.”  Not nearly as compelling as blaming it on oil prices.  People hate oil prices.

Bandwagon Fallacy

The bandwagon fallacy is commited when an implication is made that the rising popularity of an idea is proof of its truth, or at least a compelling reason why it should be accepted as true.  Anybody who remembers the late 90′s tech boom will recognize this fallacy in action.  As valuations for tech companies that had never earned a single dime became more and more astronomical, several prominent industry analysts declared it was the dawn of a “new economy” and that traditional valuation metrics no longer applied.  They then pointed at rising prices as evidence their logic was correct.  Humans have shown themselves to be quite susceptible to herd behavior and well, we all know how that turned out.  Beware the bandwagon fallacy.

Gambler’s Fallacy

The gambler’s fallacy, which is the assumption that short-term deviations from probability will be corrected in the short term, can have devastating consequences for investors.  For example, it is tempting for financial journalists and even experienced investors to ask “how low can it go” after a bout of falling stock prices.  “Stocks have fallen 10 days in a row now,” you might tell yourself.  “They are due for a rebound tomorrow.”  Not so.  Daily stock returns are what’s known as independent trials, meaning yesterday’s return has no bearing on tomorrow’s result.  As anybody who bought bank stocks recently will tell you, things can always get worse before they get better.  Certainly the market is likely to revert to the mean in the long term, but as economist John Maynard Keynes once quipped, “the market can remain irrational longer than you can remain solvent.”