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

by Nassim Nicholas Taleb

To get technical, there are even worse extensions. An outstanding recent paper by Sullivan, Timmerman, and White goes further and considers that the rules that may be in use successfully today may be the result of a survivorship bias. Suppose that, over time, investors have experimented with technical trading rules drawn from a very wide universe—in principle thousands of parameterizations of a variety of types of rules. As time progresses, the rules that happen to perform well historically receive more attention and are considered “serious contenders” by the investment community, while unsuccessful trading rules are more likely to be forgotten…. If enough trading rules are considered over time, some rules are bound by pure luck, even in a very large sample, to produce superior performance even if they do not genuinely possess predictive power over asset returns. Of course, inference based solely on the subset of surviving trading rules may be misleading in this context since it does not account for the full set of initial trading rules, most of which are unlikely to have underperformed.