Courtney Smith on Relationships (Aug. 26, 1999)

"I am a financial stock trader currently researching the predictive properties of stock market indicators. At the moment I'm using simple linear regression in order to discover whether there is a relationship between an indicators value and a stocks price. However Simple Linear regression defines only a basic relationship not a causal relationship between the variables, therefore could you possibly recommend other statistical tests that do explain a causal relationship? "

Editor-in-Chief Courtney Smith: This is a rather interesting question.

The short answer is that no statistical test can prove causality, only intuition and logic can do that. However, statistics can provide a good indication of a relationship that can be used for prediction or trading. Remember, trading is the art of making decisions with imperfect knowledge. What I do is to either start with a hypothetical causal relationship and then do a statistical test, such as linear regression or correlation analysis, and see if it proves out. Alternately, I test various indicators and then see if I can see an underlying reason for them to be related or that one is caused by the other.

Hope this helps!

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• Latest Issue of CTCR Newsletter: Review of OptionVue 5 (Aug. 15, 1999)
  
  

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