Making Money with Hindsight
We should already be aware of the problems of back-testing. While there are no other alternatives for validating a proposed trading strategy, it is necessary to look at the problems more carefully to see a solution. No market is more evident than crude oil during the Gulf War, discussed in the previous series of posts. From August 1, 1990, through the end of the War in February 1991, oil prices were driven by news. But not all news is a surprise. In the agricultural markets, a crop freeze in orange juice or coffee is often anticipated by a change in weather. Before a freeze can occur, the temperature must drop. And that low temperature must he sustained to cause damage. This weather change causes processors to protect themselves by buying forward contracts or futures. In turn, prices move up.
Because Iraq had been moving troops near the Kuwait border, their intentions were not a surprise; however, diplomacy failed. The threat of an oil supply disruption caused oil prices to slowly rise. Many systematic traders and commercials would have been long on August 7, 1990, when Iraq invaded Kuwait.