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Using the Scientific Method on Wall Street

The key word that comes to mind when I consider my trading/investing method is EVIDENCE.  Since my college education was in the field of science, it is no surprise that the use of the Scientific Method was central to the application of my studies.  The question is, “Now that I devote the bulk of my time to Wall Street, how does the scientific method follow me into this field?”

English: Flowchart of the steps in the Scienti...
English: Flowchart of the steps in the Scientific Method (Photo credit: Wikipedia)

The four steps of the Scientific Method are these:

  • Observation of a phenomenon
  • Formation of a hypothesis
  • Use of the hypothesis to predict results
  • Test the hypothesis within boundaries of clearly defined, repeatable process

So, what about investing?  At OptionsANIMAL a clearly defined, repeatable process is used to generate profitable results.  Part of this process is a series of steps that leave the person with a solid hypothesis about the equity in question.  Although there is no guarantee that all end results are alike, it provides us an ‘edge’ in our approach by leaning on the EVIDENCE of the equity.  What can we derive, in applying a scientific process from the evidence?

The EVIDENCE will lend support to one hypothesis over others.
The EVIDENCE may rule out some hypotheses.
The EVIDENCE may lead to the revision of a hypothesis.
The EVIDENCE may show a faulty assumption, causing us to possibly redesign the structure of the process.

Let’s look at a generic example:
XYZ is at a higher price than it was 3 months ago.  When we look at the Fundamentals, Technicals, Sentimentals, and the Market Environment, we form a hypothesis that it will continue to rise in price over the coming period of time.  We use this hypothesis to predict bullish results and select our bullish trading strategy by calculating the reward/risk ratio of several bullish strategies.  Now that we have formed the hypothesis we prepare our trading plan complete with a plan of action to take if the results are not as we expected.  It is natural that a revision may be needed, and our options education has prepared us with logical revisions to apply to the hypothesis.

Through this orderly process we repeat the steps on equity-after-equity, building a clearly defined, repeatable process.  If the results show wide variances, a first element to consider is ‘human error.’  Was there any deviation from the structured process?  Did human emotions derail the method?

Science gives us a dependable, measurable structure within which to apply many of our interests.  Fitting trading/investing skills into the framework of the Scientific Method is one successful approach to Wall Street!

Emilu Bailes
OptionsANIMAL Instructor

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