Like any other effort in science, the back test can vary from shallow and useless to very useful. It is a matter of the quality of information that forms the test. A shallow back test, and the discipline to stick with it, is a recipe for disaster.

The quality of information determines the significance in the numbers. Probabilities are wonderful, but they are only as good as the quality of information that forms them. Information, such as the logic behind the method is critical. It is impossible to trust the interpretation of past data where logic is absent.

In his book “Fooled by Randomness” Nassim Nicholas Taleb illustrates this problem by saying:

“I have just completed a thorough statistical examination of the life of George Bush. For 55 years, close to 16000 observations he did not die once. I can hence pronounce him as immortal, with a high degree of statistical significance”.

This is not logical, even though there is a large sample of observations. The statistics should shed light on the logical intuitions of the developer. In other words, it must make sense.

If a particular intuition is being tested (for example 20 day breakouts) it has a much higher degree of significance than throwing the computer at data and scanning for relationships. I’m sure with enough data we can find the relationship between Federal Reserve tightening and Federal Express deliveries, but it won’t have any significance.

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Charles Maley
www.viewpointsofacommoditytrader.com
Charles has been in the financial arena since 1980. Charles is a Partner of Angus Jackson Partners, Inc. where he is currently building a track record trading the concepts that has taken thirty years to learn. He uses multiple trading systems to trade over 65 markets with multiple risk management strategies. More importantly he manages the programs in the “Real World”, adjusting for the surprises of inevitable change and random events. Charles keeps a Blog on the concepts, observations, and intuitions that can help all traders become better traders.

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