Occam's Razor
A close shave.
Recently, I found myself working day and night on fine-tuning an exit strategy for one of my day trading systems. Delving into statistical probabilities and portfolio theory can quickly turn into a quagmire of data, models, and losses. One can be tempted to add more and more criteria, rules, and layers to achieve a high probability trading system.This is know in the industry as "curve fitting".
Curve-fitting
refers to the process of creating a model that closely fits a specific
set of historical data. This can lead to models that perform well on
past data but poorly on new, unseen/ future data due to over-fitting. Traders
may be misled by profitable back tested results if a model has been
curve-fitted. The model may show impressive returns and low risk in
back-tests, but these results cannot be replicated in live trading. This
is a common mistake that traders make and can be extremely frustrating
when a trader curve fits a strategy that produces wonderful back-tested
results, but as soon as it is traded in live markets, the system fails
dismally.
I found myself going down a never-ending rabbit hole in search of the perfect exit strategy, with little success. A solution to this problem can be achieved through a philosophical approach called “Occam’s Razor.”
Occam's Razor is a principle attributed to the medieval philosopher William of Ockham. The principle states that among competing hypotheses, the one with the fewest assumptions should be selected. In other words, the simplest explanation is usually the correct one.
Although this is a bit of an oversimplification, his principle is used as a guide to eliminate unnecessary complications and focus on the most straightforward path to a solution. It is applied in various fields, including philosophy, science, and medicine, to help solve problems.
Referring back to my frustration with the exit strategy I was building, I was overthinking it, instead of just trusting the numbers. Building a robust system that deals with all market conditions even though it sometimes doesn't get the perfect exit, is preferable to a curve fitted, unrealistic system with a 99% accurate back-tested system that collapses in live conditions.
It is impossible to incorporate every possible scenario when making a decision. You end up overthinking, over analyzing, and never making a decision or simply never finding a workable solution. Even worse you blow your trading account in frustration. An informed decision is a good decision. Complicating it just leads to indecision.
I’ve sometimes wondered why a less talented, less experienced, less knowledgeable trader may have greater success in the markets than a gifted trader. Occam’s Razor may be the answer.
Using Occam's razor can help a person perform better in several ways:
Decision-Making
Problem-Solving
Communication
Focus
Resource Management
Learning
Creativity and Innovation
Recently, James Clear referred to a book I read years ago called The Bell Jar by Sylvia Plath. The book is a masterpiece. The author reminds us that choosing a path means ignoring the rest, but not choosing at all means squandering them all. Here is an excerpt:
"I saw my life branching out before me like the green fig tree in the story. From the tip of every branch, like a fat purple fig, a wonderful future beckoned and winked. One fig was a husband and a happy home and children, and another fig was a famous poet, and another fig was a brilliant professor, and another fig was an amazing editor, and another fig was Europe and Africa and South America, and another fig was Constantin and Socrates and Attila, another fig was an Olympic lady crew champion, and beyond and above these figs were many more figs I couldn't quite make out. I saw myself sitting in the crotch of this fig tree, starving to death, just because I couldn't make up my mind which of the figs I would choose. I wanted each and every one of them, but choosing one meant losing all the rest, and, as I sat there, unable to decide, the figs began to wrinkle and go black, and, one by one, they plopped to the ground at my feet."
Overall, Occam's razor encourages a mindset of simplicity and efficiency. In many ways, popular concepts like mindfulness and minimalism are based on this premise. Using Occam’s Razor can enhance performance in various aspects of your personal and professional life.
Trade well,
Justin
