Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets

by Nassim Nicholas Taleb

The Backtester A programmer helped me build a backtester. It is a software program connected to a database of historical prices, which allows me to check the hypothetical past performance of any trading rule of average complexity. I can just apply a mechanical trading rule, like buy NASDAQ stocks if they close more than 1.83% above their average of the previous week, and immediately get an idea of its past performance. The screen will flash my hypothetical track record associated with the trading rule. If I do not like the results, I can change the percentage to, say, 1.2%. I can also make the rule more complex. I will keep trying until I find something that works well. What am I doing? The exact same task of looking for the survivor within the set of rules that can possibly work. I am fitting the rule on the data. This activity is called data snooping. The more I try, the more I am likely, by mere luck, to find a rule that worked on past data. A random series will always present some detectable pattern. I am convinced that there exists a tradable security in the Western world that would be 100% correlated with the changes in temperature in Ulan Bator, Mongolia.