Exactly What is Occam's Razor?
Occam's (or Ockham's - pronounced Okhams) razor is a principle attributed to the Logician and Franciscan Friar "William of Occam," who's picture is to the upper-left. Ockham was a village in the English county of Surrey where he was born in about the year 1285.
He was the most influential philosopher of the 14th century and a controversial philosopher and theologian.
The principal of parsimony is involved. A well-established test for reaching a conclusion based on limited information, such as commodities, stocks & options trading success, where there always seems to be limited trading information available to the trading public and off-floor traders!
The medieval rule of parsimony, frequently used by Ockham came to be known as Ockham's Razor, or more popularly as "Occams Razor."
The rule, which said plurality should not be assumed without necessity was used to eliminate many possible explanations. In modern English, Keep It Simple Stupid - a.k.a. KISS.
The most useful statement of the principle for traders and investors is:
"when you have two competing trading theories which make exactly the same predictions, the one that is simpler is the better & more profitable one."
It's been said, traders must use the simplest means of arriving at their results.
Occam's razor, also known as 'the law of simplicity' is often quoted in strong forms as in the following statements:
"If you have two trading/investing theories which both explain the observed facts then you should use the most simple and simplest one until more evidence comes along"
"The simplest explanation for a commodity or stock price movement phenomenon is more likely to be accurate than more complicated explanations."
"If you have two equally likely solutions to a trading or day trading problem, pick the simplest."
"The price movement explanation requiring the fewest assumptions is most likely to be correct."
... or in the only form which takes
its own advice...
"Keep things simple!"
These principles go back at least as far as Aristotle who wrote "Nature operates in the shortest way possible." Aristotle went too far in believing that experiment and observation were unnecessary.
The principle of simplicity as it related to the financial markets and trading, works as a heuristic rule-of-thumb but some people quote it as if it is an axiom of physics. It is not. It can work well in philosophy or particle physics, but less often in areas like cosmology or psychology, where things usually turn out to be more complicated than you ever expected.
Simplicity is subjective and the universe does not always have the same ideas about simplicity as we do. Successful theorists and profitable stock & commodity traders often speak of symmetry and beauty as well as simplicity.
The Research Worker, in his effort to express the fundamental laws of Nature in mathematical form should strive mainly for mathematical beauty. It often happens that the requirements of simplicity and beauty are the same, but where they clash the latter must take precedence.
Perhaps you heard the term Occam's Razor used several times in the popular movie 'Contact,' based on the book by Carl Sagan. It was used in an attempt to explain Jodie Foster's trip via Worm Holes in Space to a distant planet.
When 'Ellie' was asked if she knew what Occam's Razor meant, she explained it like this "All things being equal, the simpler explanation tends to be the right one."
The final word falls to Albert Einstein, himself a master of the quotable one liner. He warned:
Everything should be made as simple as possible, but not simpler!
That is so true in successful trading and investing, more true than you would imagine!