Karl Popper’s contributions to the philosophy of science and economics were invaluable. His way of thinking can also be useful for investors.
If an investment thesis relies on inductive reasoning, it may be a good probabilistic guess, but be skeptical. For example, consider a prediction like “Every time the economy does X, Y happens the following year. X just happened, therefore Y will happen this year.”
Why might this relationship not hold true in the future? Could this be a case of correlation, not causation? Consider the logic and assess probabilities, but don’t be persuaded with this type of evidence alone.
Investors should also remember the importance of falsification. If you find yourself persuaded by an investment idea, consider what could prove the logic wrong. If you hear a theory about a stock or market movement with a list of “reasons” supporting it, ask yourself what those reasons could be missing. Asking skeptical questions will help assess risk. As the saying goes, if it seems too good to be true, it probably is.
‘In so far as a scientific statement speaks about reality, it must be falsifiable; and in so far as it is not falsifiable, it does not speak about reality.’
Furthermore, don’t be persuaded by a theory that seems unfalsifiable. Don’t fall for a pundit’s prediction that, if the anticipated event fails to materialize, comes with a pre-programmed excuse.
‘Whenever a theory appears to you as the only possible one, take this as a sign that you have neither understood the theory nor the problem which it was intended to solve.’
Below is a short BBC video summarizing Popper’s ideas on the dangers of unfalsifiable theories: