Tuesday, August 6, 2019

"Profiting From Random Strategies"

First posted in October 2016.
From Price Action Lab:
The bulk of trading strategies are random because they are either overfitted to noise or are the result of selection bias. However, there are ways of even profiting from random strategies. In this article I outline the general idea and offer an example.

Traders are aware that the bulk of trading strategies do not offer profit potential due to data-mining bias and, as a result, most of them generate losses.

As it was shown in another article, identifying a consistently losing strategy to invert and profit from is as difficult as identifying a consistently winning strategy.

However, if one can identify random strategies that are at the end of a drawdown phase, there may be profit potential for limited time due to mean-reversion. This is because the longer-term expectation of a random strategy is 0.

This type of trading is of course highly risky because a losing strategy can continue to generate losses for an extended period of time before the expectation reverts toward 0.  The probability of identifying strategies that are about to mean revert can be maximized if there if a sufficient trade sample is available and payoff is symmetric. Therefore, this idea of trying to profit from losing strategies does not apply to small samples generated by momentum and trend-following algos, especially on weekly and monthly data; it is more suitable for intraday and daily timeframes....MUCH MORE
See also 2013's "Computer Simulations Reveal Benefits of Random Investment Strategies Over Traditional Ones".

Somehow related:

...We've looked at the phenomena in a couple other contexts:
Random Stock Selection Again Beats Index; 99.9% of High Priced Managers
There may be a problem or two with the sample size, replication, error bars, pretty much the whole statistical schmear, but if I put that in the headline would you have read this far?
From Joe Meth (Stock Chartist)...

Okay, Enough With Politics: Attention Managers, You Can Improve Corporate Efficiency by Randomly Promoting Employees
That last piece of research was awarded Harvard's own Ig Nobel prize in 2010.

Ya see, ya got your complex systems and ya got your chaotic systems and then ya got your complex-chaotic systems like weather or the economy or the stock market and when you endeavor at those levels of sophistication you realize:

Should You Just Give Up And Trade Stocks Randomly?
Joys of Noise: Technologies that Rely on Randomness
Think a coin toss has a 50-50 chance? Think again.
Randomness: "A Drunkard’s Walk in Manhattan"