Survivorship Bias In Trading (How To Avoid It) – Backtesting, Trading And Investing
Survivorship bias in trading and backtesting is about the things we don’t see or to a certain degree ignore. We tend to see the winners and not the losers. Unfortunately, this is very typical in trading and backtesting. To avoid this, you need to understand what survivorship bias in trading is.
In this article, we describe what survivorship in trading is and how survivorship bias influences backtesting, trading, and investing. We show examples of survivorship bias, how survivorship bias overestimates your backtests, and how you can avoid and minimize survivorship bias in trading and investing.
Unfortunately, almost all traders ignore survivorship bias, either on purpose or lack of knowledge.
Why is it important to understand survivorship bias? It’s important because it overstates backtested results and leads to many disappointments when you start live trading. Additionally, understanding survivorship bias is also an asset in everyday life.
(Before we go on we’d like to mention that we have a backtesting course that covers all aspects of how to backtest.)
Survivorship bias is invisible in backtesting, trading, and investing:
Survivorship bias is about the things we don’t see or to a certain degree ignore.
We like success stories about super-traders/investors or entrepreneurs, and we “forget” to look at the probabilities for success and look at all those that fail. Decision-making is not only about tangible results, but just as much about what Nassim Taleb calls alternative histories. The same goes for economics: it’s just as much about a study of what we don’t see, opportunity costs, and unintended consequences.
Why it is important to understand survivorship bias in backtesting
In all aspects of life, success stories are more prevalent than fiascos. We hear rock stars on the radio, we see business tycoons in the news, and we read about miracle cures in medicine.
But we rarely hear about the losers and the fiascos. Thus, we succumb to illusions and overestimate the probabilities of success. For every rock star, there are probably 1 000 “failed” musicians. For every successful author, there are probably 100 who fail to make ends meet.
It’s the same in the stock market. Most listed companies fail to beat short-term Treasury bills, according to Hendrik Bessembinder:
Hendrik Bessembinder reveals most stocks fail to deliver meaningful returns
Most stock market