Avoiding the Post Hoc Fallacy

When you first get into trading, many people try to make sense of market movements, but in doing so many also fall into a Post hoc ergo propter hoc mindset.

This is Latin for "after this, therefore because of this", and is an informal fallacy that essentially means "Since this second event followed this first event, the second must have been caused by the first event." Often people just shorten it to the Post hoc fallacy. This is a common problem for stock traders, and even worse at times in the crypto community.

Take for example the following scenario...

Quote

Bitcoin has been trending steady for a number of months, when the Aldi grocery stores (an international chain) announce that they will now accept Bitcoin for in-store purchases. Overnight, Bitcoin shoots up by over $600, or 15%. You recognize this and think, "Okay, grocery stores adopting Bitcoin leads to an increase in price, so I will invest in Bitcoin right before another chain makes an official announcement that they will begin to accept Bitcoin.

That is the basis of many people's trading strategy but unless you do a good deal of research it can cause you terrible losses. That scenario may be true, Aldi accepting Bitcoin may have caused a surge in market activity in the upwards direction, but if that was the extent of your research, what you may have missed was that on the same day, India legalized the use of Bitcoin for paying property taxes. If you didn't do thorough research, you could easily assume "if this, then therefore that" about the grocery store adoption and make a poor investment based on that fallacy.

This fallacy can also be a problem because these price movements aren't always in the same direction. Take for example the same scenario as above, but instead of legalizing cryptocurrency for paying property taxes, India took down the largest exchange somehow and the price of bitcoin fell rapidly. If you didn't research that and only saw the grocery store news and then saw the price drop, you might make the opposite conclusion, that somehow Aldi adopting Bitcoin pushed the price down. Large price movements can hide useful knowledge about other smaller price movements.

tl;dr
Do your research... thoroughly, especially when you want to start making assumptions about price movements using the news and current events.