A Priori Probability
What it is:
How it works (Example):
A priori is Latin for "deductive" or "presumptive." An a priori probability is deduced rather than based on past behavior. In other words, the method looks to logic rather than history to determine the probability that something will happen.
For example, let's assume that Company XYZ's stock closed at $10 yesterday. Based on the last several days of trading history, the stock seems like it's on a hot streak, so investors give the stock a 66% chance of increasing again tomorrow.
However, a priori probability, Company XYZ's stock can only do one of three things: Go up, go down or stay the same. Accordingly, there is only a 33% chance that the stock will go up tomorrow.
Why it Matters:
Generally, in the investing world, a priori probability refers to probability based on reason alone rather than perception, insight, memory or history.