01 October 2009

Practical Decision-Making: A Priori versus Empirical Reasoning

"In times of change learners inherit the earth; while the learned find themselves beautifully equipped to deal with a world that no longer exists." Eric Hoffer
A Priori:
from Latin, literally "from the former." Reasoning that starts from accepted first principles or facts requiring no proof or foundation, being a self-evident assumption to the true believer
a. Relying on or derived from observation or experiment: empirical results that supported the hypothesis. b. Verifiable or provable by means of observation or experiment: empirical laws. 2. Guided by practical experience and not theory,

A Priori reasoning is often associated with religion and other belief systems, because it is 'top down' reasoning from a given, accepted fact that is judged to be self-evident and sufficient in itself. So for example, if one believes in an all-powerful and loving God, one can start making logical deductions from that first principle.

Empirical reasoning is often associated with the 'scientific method.' This is reasoning from the "bottom up" based on data, evidence and replicable experimentation and demonstrable relationships. Empirical reasoning can only take one so far, and generally follows the pattern of hypothesis - proof - re-examination - new hypothesis based on new data or insights.

In Economics, it never ceases to amaze how quickly people gravitate towards a priori reasoning once they have become wedded to a belief in an idea, a trading system, a school of thought, or a cult of personality.

If I believe, for example, that deflation is inevitable, no matter what else, then I will selectively choose data to support this view, even if unconsciously, and evaluate all information in the light of deflation as a given outcome, accept that which supports my belief, and rejecting or diminishing in significance the contrary data.

One can make the same case, for example, for those that believe that hyperinflation is an inevitable outcome in the near term. Or those who believe in the infalliblity of a particular trading system such as Elliot Waves, or some favorite indicator.

In less lofty terms, it is what we call a prejudice, although that term has become too specifically associated with racism in the modern world. It is literally a prejudging of situations, and fitting them all into a common pattern no matter what.

Sometimes the lengths to which true believers will go to hold on to their opinions becomes almost funny, if it is not so often accompanied by ad hominem attacks and rather nasty, immature behaviour when the true believer becomes cornered by reality. Or the tragedy of genuine loss when believers are led into folly and the consequences of their errors.

How funny is it, for example, to see a noted pundit keep drawing lines in the sand for the maximum price appreciation of a commodity like gold, and having to change them every year, ignoring past failures and pretending as though they have not been wrong, not daring to acknowledge their failure and attempting to explain it, to at least integrate it into their system in some credible manner.

There is always an alternate count, always the oddly possible but highly improbable excuse or rationale for their own mistaken belief, to avoid admitting that they or their system are imperfect, that they do not know the future with any certainty.

One can believe in something that might eventually become true, but for the wrong reasons. The 'belief' part is accepting the truth before any rational evidence would lead one to accept it logically. It really depends on the odds, and whether they get 'lucky.' People are therefore fooled by chance.

This by the way is the problem I have had with some of the adherents to the Monetarist and Austrian schools of economics, among others gathered in schools. They believe something, and are inclined at times to twist the data to support their predispositions and claims, and reduce objections or alternate views to caricatures that are not correct on close examination by the unbiased mind.

A scientific approach is to assess what is, rather than what we would like things to be, and to draw conclusions carefully from it, calculating probabilities when the evidence does not support a single outcome, and a willingness to accept new data and act on it when it appears, even if it appears contrary to a current working hypothesis.

This does not mean it is wrong to carefully examine evidence that seems to be 'on the tails' of our existing body of knowledge, to see if an adaptation of the hypothesis is all that is required.

Why is this important to us here in this forum?

Because belief is in the realm of the spiritual and the philosophical. Even a statement like "it is self-evident that all men are created equal" is clearly an appeal to a philosophical stance.

Finance, business, trading are not worthy of belief excepting for the ethical implications of behaviour that is contingent on all realms of human endeavor, depending on what one believes.

So, in trading, one should try to avoid becoming a 'true believer' in one idea or person or system. They are all likely to be flawed, and will very often blind the believer to the reality of the situation, so that they can lose impressive amounts of money fruitlessly following a belief that has no validity in their particular case.

In other words, no one knows the future for certain. There are always probabilities involved in every situation, every outcome. Some are more easily discerned than others, but they tend to be in the long and short term trends.

People naturally tend to carve the 'hits' or successful predictions based on their system or belief in marble, and write the 'misses' in sand. They tend to fool themselves as a portion of the belief in what they think must be true. It is a natural, but potentially deadly, behaviour.

In religion, faith alone can lead one to do outlandish things as in the South Seas cargo cults. So there is the thought in the western tradition that one relies on faith and reason together. But of course reason can only take one so far, and then one is faced with what Kierkegaard called 'the leap of faith.'

One might be willing to 'lose money' for the sake of righteousness by refusing to engage in unethical behaviour in their business activity. But foolish is the person who loses money because they have put their faith in human error, in party politics, in groupthink, and profane beliefs.

On an almost daily basis I see otherwise intelligent people making this mistake, and Wall Street takes advantage of it, to the max. I have made this mistake in the past. Overcoming it is one of the great steps towards becoming a successful trading and maintaining a balanced life of the material and the spirit. We render unto Caesar that which is Caesar's, but what is God's is God's.

When the leap of faith is applied to the deployment of a trading account it is too often results in a leap off a cliff. When faith is misplaced in an ideology such as natually efficient, self-regulating markets, or state planned command economies, it can take whole nations into the abyss.