Art by: Ullamaija Hänninen http://www.ullamaijahanninen.net/
"Would these strategies work in real life trading?"
"Isn't someone already doing this?"
These are the key questions most of you have been thinking out loud, after reviewing our previous posts about strategies. In fact, these questions are so essential that we decided to write about them in this post.
The first one is perhaps the most critical one. The answer to the question,"Would these strategies work in real life?" is, to be honest:
We can't be sure unless we try.
But what we do know for sure is which strategy to try first. Investment decisions are complex decision-making problems including numerous of different criteria. Is returns the only determinant of success? How much uncertainty do we face? How much risk can we take.
Simulating (backtesting) and real-time trading with non-existing wealth (paper trading) is our way of generating information to support our decision making in such conditions. In fact, how often does a regular investor have a chance to simulate their strategy before trading with actual money? How often are we willingly testing our logic and challenging our own view?
Simulation generates information, which we use while making the decision on which strategies to employ.
The second often met question is: "Are you sure that someone isn't doing this already". Once again the answer is:
We don't know. Probably someone is.
But let's turn it this way:
If someone were to ask me, if I was sure, that no one else is doing the same fundamental analysis on stocks than I am, the question would be trivial. Most investors, including us, use the general valuation methods such as DCF and PE. After all, taking investment decisions is just believing in your own hypotheses, which you think you have validated more appropriately than the rest of the investors.
This competition between investors and traders drives adaption and innovation and thus has a comforting side. It makes the market more efficient. That is our purpose in the economy. (See Andrew W. Lo's article)
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