As a idea experiment, imagine taking every technical indicator out in that location too conducting a large factor analysis. The element analysis would bring down the release of indicators to a smaller cluster of factors that are relatively uncorrelated.
This is of import because it turns out that many indicators, from a purely mathematical advantage point, are criterion the same thing. Influenza A virus subtype H5N1 14-day RSI, for instance, may correlate real highly with a 14-day charge per unit of measurement of alter too a 14-day stochastics. If you lot hold off at all 3 indicators, you're actually looking at 1 variable measured 3 ways, non 3 unique variables.
What you lot actually wishing are unique variables that are significantly correlated with forrad cost movement.
The bad tidings is that the many technical indicators out in that location actually merely boil downwards to a handful of unique variables. The expert tidings is that, overall, these unique variables create possess statistically meaning predictive validity with honour to the prospective motion of stock index prices. The challenging tidings is that fifty-fifty this meaning predictive value leaves the lion's part of the hereafter motion of stock index prices unexplained.
So imagine I position a handful of unique predictive variables from with the large array of technical indicators too I position the expressions of those variables that minimize their overlap. From these few variables--it's of import to bring down the likelihood of overfitting the data--I comport a regression analysis too become far at a statistically predictive model over an identified marketplace position regime.
Over the regime, let's tell the model has been 65% accurate inwards forecasting the management of S&P 500 Index prices over the adjacent 3 trading sessions. When the model has given its strongest signals (top quartile of forecasts), the average three-day make inwards SPY has been .64%. When the model has given its weakest signals (bottom quartile of forecasts), the average three-day loss inwards SPY has been -.28%. This surgical operation has held upwards good inwards out-of-sample testing.
Is this a expert model? It possesses a statistically meaning "edge" too silent its R-squared, the amount of variance accounted for inwards hereafter index prices, leaves most 90% of hereafter activeness unpredicted. Influenza A virus subtype H5N1 total 35% of the time, the model has been incorrect inwards identifying hereafter cost direction. And yet, a model that gets marketplace position management correct two-thirds of the fourth dimension is meliorate than throwing darts, assuming that nosotros stay inwards the stationary regime that nosotros backtested (an of import assumption).
What quantitative function accomplishes for me psychologically is that it clearly identifies what is known too what is unknown. It gives me a feel for when in that location is an objective border too it provides a feel for the fragility of that edge.
Does quant modeling "take emotion out of trading"? No, but it does something to a greater extent than important. It replaces the emotions associated with overconfidence too confirmation biases with a dissimilar laid upwards of emotions: the humble honour for what is unknown, the wishing to expand the frontier of the known, too the felt imperative to rapidly adjust to what Victor Niederhoffer calls "ever-changing marketplace position cycles".
Further Reading:
Predictability every bit a Market Variable
Quant Reading:
See publications department of Marcos Lopez de Prado's site
