I have finished rereading David Aronson’s book Evidence- Based Technical Analysis, Applying the Scientific Method and Statistical Inference to Trading Signals, a book I bought back in November 2007. This is no easy read and a bit technical, but worthwhile its price tag. The book is very good for those who have no background in statistics. It’s a great book to get to know statistics without having to learn the mathematics behind the theory.
Who is David Aronson?
David Aronson got interested in technical analysis as early as the 1950s. He later went on to write technical memos for Merrill Lynch and later advised Tudor Investment Corporation in 1990.
He has wide experience in writing trading systems and how to apply artificial intelligence to trading. Aronson applied data mining to traditional computerized trading strategies.
What is the scientific method?
The book is divided into two parts. The first part examines how you can apply the Scientific Method to test your strategies. Aronson writes how you can apply the scientific method and statistical tests to determine the significance of your trading signals:
The scientific method is the only rational way to extract useful knowledge from market data and the only rational approach for determining which TA methods have predictive power. He calls this evidence-based technical analysis (EBTA).
The first 7 chapters are all about statistics and how to use that in testing/trading. It gives a good explanation of statistical inference, frequency distributions, standard deviation, confidence intervals, data mining, probabilities, and p-value. Especially the chapter about data mining is interesting. Aronson is good at explaining in a simple manner so all these technical concepts are easy to understand. He also explains how it’s possible to derive sampling distribution on back-tested results: the Bootstrap and Monte Carlo simulation. The author argues that these two methods are the most important test you can perform on your sample to identify the degree of randomness.
The second part of the book consists of tests of 6402 trading rules.