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Lin for the Win?
Linsanity? Hardly. For the few human beings on this planet who have no clue of what I am talking about, I am of course, referring to Jeremy Lin -- the new sensational point guard of the New York Knicks who has caught the imagination of fans from Brooklyn to Beijing and every point in between. Mr. Lin, a Harvard educated (3.1 GPA!) Asian American athlete, has become the Cinderella sensation of the sporting world and really the world at large as people everywhere marvel at his unexpected success in the most competitive basketball league on the planet.
However, Mr. Lin’s meteoric rise is only part of the story. The deeper question that has plagued sports aficionados and lay people everywhere is -- how could so many basketball clubs have missed his talent? Prior to the Knicks, Mr. Lin was bounced from several teams and his unlikely rise in New York was more luck than plan after he was allowed to come off the bench to fill in for injured teammates.
It turns out that Mr. Lin’s story is not all that unusual. Professional sports franchises spend millions upon millions of dollars on scouting and evaluating and their results are no better than a toss of the coin. Don’t take my word for it. That’s the finding of a very thorough study by economists Frank Kuzmits and Arthur Adams who examined the outcomes from the National Football League combine. The NFL (American football) is probably the world’s wealthiest sports league. Every year it runs a scouting combine for prospective players which includes everything from the 40 yard dash to a battery of psychological tests. Yet after an absolutely exhaustive array of tests and reams of personal data the NFL scouts are still unable to measure talent accurately.
Mr. Kuzmits and Adams conclude, “Using correlation analysis, we find no consistent statistical relationship between combine tests and professional football performance, with the notable exception of sprint tests for running backs. From a practical standpoint, the results of the study should encourage NFL team personnel to reevaluate the usefulness of the combine’s physical tests and exercises as predictors of player performance” The actual numbers were 52% accuracy rate or slightly better than flipping a coin.
So what does this have to do with trading? Just about everything. In trading we love the idea of using data to derive our decisions. The most common question to any new idea and one that I truly despise is -- “Have you backtested it yet?” The truth of the matter is that there is nothing more dangerous that an good looking back test with 45 degree equity curve. It is almost a perfect guarantee for failure. In fact once when I was in one of my more facetious moods I considered creating a system that would fade every single 45 degree backtest that ever came across my desk.
The truth of the matter is that trading like any other human activity is just too complex, too mysterious to predict with any degree of certainty by simply analyzing reams of data. That is why all quant models ultimately fail. Successful trading is a qualitative activity -- as much art as it is science. Some of the best trades you makes are the ones you do not take. The single most important aspect of trading is to know when your strategy will likely fail and stand aside at that time.
This past Wednesday when I MCd a webinar with my friend Rob Booker I watched him demonstrate an Ichimoko cloud strategy that looked intriguing, but what really caught my eye was Rob’s insistence to NOT take trades too quickly after a loser. That told me that Rob was a true trader who understood the limitations of his strategy, making it much more likely that he would succeed.