Evidence Based Technical Analysis

Original website: https://www.wiley.com/en-us/Evidence+Based+Technical+Analysis:+Applying+the+Scientific+Method+and+Statistical+Inference+to+Trading+Signals-p-9780470008744

Original price: $110

Content: Evidence-Based Technical Analysis.pdf

What you take-away from a reading of this book really depends on where you’re coming from.

For STATITICIANS with an interest in trading markets–You’ll likely walk away with the feeling: “Yeah, that’s what I’ve been thinking for years, nice to see someone took the time to debunk the TA myth.”

For TECHNICIANS (traders) with an interest in statistics–You’ll likely walk away thinking “You gotta be kidding. There are a hundred good books which can show you how to use TA to make money. This book sucks.”

Aronson suggests that the truth does NOT lie in between– He is firmly in the camp of the Statistician.

But a close reading of this powerful book does not “close the door” on profitable TA, it simply confirms what every first-year MBA learns:

“No OBJECTIVE black-box trading strategy CONSISTENTLY beats the market AVERAGES over the LONG TERM.”

But hard-core TA fans take heart. You will find something interesting in this book also. I’m certain Aronson would agree with the following:

“Sure you can add COMPLEX rules to the black-box, and PERIODICALLY find runs of profitability with TA. If EXCESS returns exist only in the SHORT TERM, hey, that’s good enough for me.”

For those not willing to take the time to digest the painstakingly presented statistical concepts, there will be little value in this book– This is a serious study with lots of math. Its not hard math. But math best understood after fully internalizing a college level stats class.

Even for those with a Stats or Econometrics degree statistics are tough–both computing and interpreting statistical data takes a little work. To complicate the issue, market-related statistics are fraught with half-truths, mind-bending math, and wall-street lore.

This book goes a long way to put bogus TA lore to rest by presenting a clear, scientifically sound procedure to test Technical rules.

For those seriously considering buying this book let me suggest that you find Aronson’s website […] and download and read Dr. Timothy Masters’ .pdf “Monte-Carlo Evaluation of Trading Systems.” The document, both in tone, and sophistication, mirrors Aronson’s book.

If you like Masters’ 43 page doc–you will love Aronson’s 500+ page book.

The Review

I break the book up into four parts, each with various degrees of usefulness depending on your background–ie: Technician or Statistician. Below, I’ll simply give what I thought was the “money-quote” from each part, plus a couple of observations for those considering buying the book.

***** Part 1: Chapter 1 – 31 pages
Objective Rules and Their Evaluation

“The isolated fact that a rule earned 10 percent rate of return in a back test is meaningless. If many other rules earned over 30 percent on the same data, 10 percent would indicate inferiority, whereas if all other rules were barely profitable, 10 percent might indicate superiority.” – Aronson, page 23

Constructing Rules – Intro to bi-modal rule construction and trigger thresholds
Data Transformation – Nice review of position-bias, log-differences and testing biases
Benchmarking Rules – Good review of why “Relative-Benchmarking” is important
Beating the Benchmark – Why a profitable back test is not conclusive proof of good rule

***** Part 2: Chapters 2-3 – 130 pages
The Illusory Validity of Subjective Technical Analysis
The Scientific Method and Technical Analysis

“Statistician Harry Roberts said that technical analysts fall victim to illusion of patters and trends for two possible reasons. First, the “usual method of graphing stock prices gives a picture of successive (price) levels rather than of price changes and levels can give an artificial appearance of pattern or trend. Second, chance behavior itself produces patterns that invite spurious interpretations””– Aronson, page 83

The Eye Deceives – Charting a random process and the representativeness heuristic
Subjective vs. Objective — Why its important to be able to “hard-code” a TA rule
The Role of Logic – Why “Falsification” is more important than “Affirmation” in TA
Astrology vs Astronomy – Pushing the TA boundaries from pseudo- to science

***** Part 3: Chapter 4-7 – 230 pages
Statistical Analysis
Hypothesis Tests and Confidence Intervals
Data-Mining Bias: The Fool’s Gold of Objective TA
Theories of Non-Random Price Motion

“Informal data analysis is simply not up to the task of extracting valid knowledge from financial markets. The data blossoms with illusionary patterns whereas valid patterns are veiled by noise and complexity. Rigorous statistical analysis is far better suited to this difficult task.” – Aronson, page 172

Hypothesis Testing–Good review of probability and statistical inference
The Traditional Solution – Actually put your college-level stats knowledge to use
The Monte-Carlo Solution – Putting computer randomization and re-sampling to work
The Data-Mining Problem — Why traditional MC solutions don’t work
Inefficient Markets – How, where and why profitable TA rules should STILL exist

***** Part 4: Chapter 8-9 – 100 pages
Case Study of Rule Data Mining for the S&P 500
Case Study Results and the Future of TA

“Few rule studies in popular TA apply significance tests of any sort. Thus, they do not address the possibility that rule profits may be due to ordinary sampling error. This is a serious omission, which is easily corrected by applying ordinary hypothesis tests.” – Aronson. page 449

The Operators – Reviews: channel-break-outs, moving averages, channel-normalization
The Indicators — Reviews: price, volume, breadth, spreads, yields
The Rules – Reviews: trends, inverse trends, reversions, divergence
The Results – Analysis of why 0 of the 6,402 tested rules produced no significant results

The Bottom Line

Aronson’s book reminds me of that masked-magician on TV who has given away the secrets to all the best stage illusions.

Novice magicians and apprentice conjurers will undoubtedly be “pissed-off.”

But true professionals are liberated.

The best in the field can focus on new and potentially MORE exciting illusions–not the same old tricks.