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The Scientific Method and the Market

Investments is alone among modern human endeavors in having largely escaped the influence of the scientific method. As a result, the field is ruled by untested nostra and outright superstition, particularly in the writings of the media and books aimed at the public. Academic work is hardly better, as any chance of being of any earthly use is rendered null by old data, unfruitful lines of inquiry and an innocence of the real world of trading with its vig, commissions, fees, spreads, deceptions and ever-changing cycles.

This state of affairs drove us to write Practical Speculation (John Wiley & Sons, March 2003). Although our predictions were borne out in the subsequent year, the book went unreviewed by the popular media and quickly became a worst-seller even as screeds predicting -- incorrectly, as it turned out -- imminent market doom became bestsellers. (In fairness, some reviewers in the trade media called Practical Speculation "possibly the best trading/investment book ever written" (Gary B. Smith, thestreet.com), and "the best trading book of the young millennium" (Active Trader Magazine, May 2003).

Undaunted, we continue to mount the soapbox. After all, why should knowledge about wealth, one of the most important thing in life, remain in the Dark Ages? A selection of our recent writings on the scientific method appears below:

Beware of Retrofits (Vic 2/3/4): When I was a boy, there was a program called Automatic Interaction Detector that would find the optimal binary splits on x independents, nested to predict a dependent. It seemed so good on paper, but it was useless. I believe its successor is called CART. It don't work because it implicitly has thousands of hypotheses that it examines to retrofit a mainly random phenomenon. Also, when the results aren't random or  explained by multiple hypotheses, the cycles are ready to change. Such defects apply to almost all the work of quant shops on Wall Street in particular, and to technical analysts in general. When they test things, they have many splits, many hypotheses, many exceptions based on lame duck or the Iraqi War that retrofit their data. Read more>>>

The Difficulties of Science: Momentous advice given by Enrico Fermi to the young Freeman Dyson in 1953, recounted in an extraordinary essay in the Jan. 22, 2004, issue of Nature, holds a crucial lesson for all who would apply counting to the field of speculation