In today’s fast-paced world of trading, it can be tempting to chase after the most complex and sophisticated strategies to try and stay ahead of the competition. However, greater complexity is not always better. In fact, there is a growing body of research that indicates simple is often better. This also matches the viewpoint of Toby Carrodus, a seasoned trader with a wealth of experience in the industry. In this article, we’ll explore his insights into the principles of successful systematic trading, with a focus on the importance of simplicity.
This article first appeared here: https://bitrebels.com/business/toby-carrodus-benefits-simplicity-why-parsimonious-trading-models-better-age-ai-hype/
Toby Carrodus argues that, despite the appeal of complex models and strategies, these are often less effective than simpler alternatives. He cites the work of Kahneman, Tetlock, and Meehle, who found that “complexity may work in the odd case, but more often than not it reduces validity.” Simple combinations of features, according to this research, are often more effective.
Carrodus’ experience echoes this finding, as he himself has been involved with research projects over the years where researchers tried to outdo each other by adding more and more complex features, with the result being more complicated yet fragile models that yielded statistically insignificant changes.
Simplicity Requires Hard Work & Education To Appreciate But Complexity Sells Better
One of the reasons why simplicity is often overlooked is that it requires hard work and education to achieve, while complexity can be sold more easily. Complex models signal effort, intellect, and innovation, whereas simple models may be dismissed as lacking in validity.
Complexity also sells better in a professional environment, where it can be used to demonstrate an individual’s intellectual prowess or a company’s expertise and resources. In reality, however, many of the models used by hedge funds are relatively simple, and the teams of PhDs they hire are primarily for marketing purposes, so-called “window dressing.”
Carrodus Recommends Price-Based Signals
To achieve simplicity in trading, Toby Carrodus recommends focusing on price-based signals. He’s a big fan of this approach because it simplifies the sort of data being processed and provides faster feedback on whether signals are working or not. The link between fundamental data and prices is often tenuous. Prices themselves already contain a wealth of information, such as autocorrelation, correlation, and volatility.
“By focusing on price-based information, traders don’t necessarily need to be subject matter experts to be successful”
Toby Carrodus explains that market prices are a way of communicating the knowledge and information of millions of economic actors in a condensed and abridged form. By focusing on price-based information, traders don’t necessarily need to be subject matter experts to be successful.
Parsimonious Models Reduce The Risk Of Fitting To Noise
Toby Carrodus argues that another way to achieve simplicity is to prefer parsimonious models, with a low number of parameters relative to the amount of data available. Models with too many parameters are often tuned to both signal and noise, reducing their statistical forecasting power.
In trading, the temptation to include more and more parameters to fit historical data can lead to poor predictions when applied to new data generated by the same underlying process. Carrodus explains that this basically means the more parameters you specify, the less reliable your trading system and expected profits are.
“Models with too many parameters are often tuned to both signal and noise, reducing their statistical forecasting power”
In general, Toby Carrodus emphasizes the importance of simplicity in systematic trading. Despite the appeal of complex models and strategies, the evidence supports the use of simple combinations of features.
Price-based signals and parsimonious models are two ways to achieve simplicity in trading, and these approaches have the potential to be more effective and efficient than their more complex counterparts. By focusing on simplicity, traders can avoid the pitfalls of complexity and improve their chances of success in the fast-paced world of trading.