Transductive reasoning is a type of flawed logic that is most commonly used by very young children to connect meaning between events where there is no correlation. With adulthood it takes the form of superstition or being fooled by randomness.
Transductive reasoning causes people to think there are connections between events that are not accurate based on past experience, patterns, or belief systems.
Examples could be that Amazon packages are delivered in the afternoon. One day an Amazon box comes in the morning, so a kid thinks that it is the afternoon and it’s time to to have lunch.
Another example could be that since pants have stripes and a shirt has stripes, they match because the patterns are the same but in reality the colors clash.
Another great example is a child hears a dog bark and then sees a train arrive. He concludes that the train comes because the dog barks.
Transductive reasoning is characteristic of children between 2 and 7 years of age.
Transductive reasoning can be an important part of intellectual development. It’s what happens when a child starts reasoning and trying to make logical cause and effect connections out of circumstances. Though the early inaccurate conclusions can be funny or make parents worry about intellectual development it shows that the child is thinking and the executive functions are building in their brain.
With adults it takes the form of superstition as bad events on Friday the 13th are seen as due to the day of the week and month correlation. Bad luck is attributed to a black cat crossing someone’s path or walking under a ladder. The events have no correlation in reality but are connected through transductive reasoning.
In investing, one example of transductive reasoning that is false is The Super Bowl Indicator. This superstition states that the stock market’s annual performance can be predicted by the outcome of the Super Bowl in that year. Leonard Koppett came up with it in the 1970s and at the time he discovered the false correlation it had never been wrong in history.
This investing signal is given based on the conference the NFL team is from that wins the super bowl in that year. If the AFC wins, then it will be a bear market, but if a team from the NFC wins or even a team that was in the NFL before the NFL/AFL merger wins, it will be a bull market. As of January 2020, this indicator has been right 40 out of 53 times, based on using the S&P 500 Index as the benchmark, it has a historical win rate of 75%.
The error in this thinking is caused by being fooled by randomness. The biggest problem in this data set is that there is zero correlation to the NFL and the stock market. Another problem is that the sample size is so small it was easy for any pattern to emerge in the 1970s as the Super Bowl only began in 1967. Also the fact that the NFC had several dynasties in their conference like the Green Bay Packers, Dallas Cowboys, and the San Francisco 49ers and the stock market is bullish on the majority of years it made the correlation much easier to fool people.
Also in investing buying in a bull market does not translate into skill unless you keep those profits during bear markets or hold long enough to be profitable in your holding timeframe.
In trading the biggest transductive reasoning error occurs when a new trader confuses luck with skill. Making money for days, weeks, or months can be attributed to luck while profiting year over year for a decade can show trading skills. Blowing up a trading account shows that a trader lacks risk management skills.
A trader bullish on dotcom stocks in the late 1990s could just be lucky, a trader that kept the majority of those profits after March 2000 and September 11, 2001 may have real skills as they had an exit strategy not just an entry.
Being bullish on Bitcoin early does not make someone a skilled trader or investor if all the other crypto currencies they bought may have dropped 99%. Bitcoin may have just been a combination of luck in both belief and timing when they bought it. The skill of a Bitcoin bull will be determined by how much they benefited from their profits in the long term.
Transductive reasoning is the error of connecting dots that are not related to one another. Correct reasoning is seeing the real cause and effect in reality.