For every one of our failures, we had spreadsheets that looked awesome—-Scott Cook, founder of Intuit
One of the real bugaboos in finance is confirmation bias. Confirmation bias is the tendency to look for what you want to see. Coupled with cognitive dissonance—the desire to reconcile your actions and beliefs—it causes all manner of terrible decision-making.
The naive view is that we all have certain firm beliefs and we endeavor to act appropriately, so that our beliefs and actions are aligned. Lots of psychological research shows otherwise. In fact, we make decisions (act) and then construct our beliefs so as to rationalize those decisions! Confirmation bias comes in handy here, because it allows us to see what we want to see, thus making rationalization much easier.
Like Scott Cook said, anyone can construct an awesome spreadsheet, but does it actually conform to reality?
If you are a researcher into systematic investment processes, it is easy to fall into this trap. You have a great idea that should work theoretically—and when you test it, it is fantastic. Yet when you try to implement it, somehow all sorts of problems crop up. You, my friend, have just become a victim of confirmation bias.
An appropriate testing process proceeds by using the scientific method—by trying to disprove your hypothesis. You want to make sure that the phenomenon is real by testing it lots of different ways, to see if you can make it break. If the process is robust and resistant to all of your attempts to beat it up, you might have something beyond an awesome spreadsheet.
The best thing about our testing process is that it has survived and thrived in the real world—repeatedly. The reason that the Arrow DWA Balanced Fund (DWAFX), the Global Macro strategy, the Arrow DWA Tactical Fund (DWTFX), not to mention the Systematic RS separate accounts and the old Rydex Dynamic Advantage program before them, have performed well in the real world is due to a realistic and robust strategy test. The next best thing about our testing process is that all of our investment processes are designed to be adaptive. This is not to suggest they will never have losses or periods of underperformance—they can and do, like any other strategy. But when the environment changes they are designed to change along with it and conform to the new trends. Rapid trend changes always create uncomfortable adjustment periods, but investors are typically rewarded for their patience with relative strength as a return factor.
For more information on our robust testing process, you may read our whitepapers here and here. If you are interested in third-party research on relative strength, you may find resources here.
For information about the Arrow DWA Tactical Fund (DWTFX) and the Arrow DWA Balanced Fund (DWAFX), click here.
Click here and here for disclosures. Past performance is no guarantee of future returns.
