Sterling Terrell

Some say the key to prediction is more / better information.  At the same time, can’t too much information be overwhelming?

Statistician, Nate Silver calls this overload of information, the “noise.”  He makes the point that in today’s world of big data, the difficult task is to separate out the “signal” from the “noise.”  Basically:  What information matters?  And what information doesn’t?

This overload of information is the case with predicting heart attacks.  Writer Malcolm Gladwell tells the story of Cook County Hospital in his bestselling book:  Blink: The Power of Thinking Without Thinking.

During a Q&A on this issue, Gladwell had this to say:

One of the stories I tell in Blink is about the Emergency Room doctors at Cook County Hospital in Chicago. That’s the big public hospital in Chicago, and a few years ago they changed the way they diagnosed heart attacks. They instructed their doctors to gather less information on their patients: they encouraged them to zero in on just a few critical pieces of information about patients suffering from chest pain–like blood pressure and the ECG–while ignoring everything else, like the patient’s age and weight and medical history. And what happened? Cook County is now one of the best places in the United States at diagnosing chest pain.

So what do predicting oil prices and predicting heart attacks have in common?  Exactly what I have already implied:  Maybe more information is not always better.

Is there a simpler way – a way that does not give most of us a headache?  Is there something that anyone can easily follow that would give us insight into all of the available information on oil?  A variable that allows us to tune out the noise, and focus on what matters?

There is:  It’s the price!

Every variable, both known and unknown that are influencing and constantly setting the current, and future, price of oil are captured in the price.

By using the price of oil to forecast the price of oil, a simple prediction rule might be:

If oil prices are moving higher – we predict higher prices.
If oil prices are moving lower – we predict lower prices.

Most traders call this prediction method: “Trend-following.”

Trend-following trading, however, is not really a prediction at all.  Like the name says:  It’s following.

In this method, you are simply saying:  “I have no predictions or ideas or preconceptions about where the market is going.  But wherever it goes, I will follow it.”

Just to show the idea, let’s make a few imaginary predictions (post-hoc) using only the price of oil as our indicator.

If the green line (the 15 day moving average of prices) is above the red line (the 30 day moving average of prices), we predict that prices will go higher.

If the green line is below the red line, we predict that prices will go lower.