WE do backtesting in finance, that is we guess hypotheses/premises and then use previous data to verify it. https://en.wikipedia.org/wiki/Backtesting. https://www.investopedia.com/terms/b/backtesting.asp#:~:text=Backtesting%20is%20the%20general%20method,to%20employ%20it%20going%20forward. Is backtesting inductive or deductive reasoning ( here we have a hypotheses/premises first so I am confused) ?
1 Answer
Backtesting would generally be considered a form of inductive reasoning rather than deductive reasoning. Deductive reasoning involves drawing conclusions that are guaranteed to logically follow from stated premises. For example:
Premise 1: All men are mortal. Premise 2: Socrates is a man. Conclusion: Therefore, Socrates is mortal.
The conclusion necessarily follows from the premises based on the rules of logic.
Inductive reasoning involves making generalizations from specific observations. Conclusions reached via inductive reasoning are probable but not certain. For example:
Observation: The sun has risen every day for as long as we have recorded. Conclusion: The sun will probably rise tomorrow.
The conclusion is likely given the evidence, but not guaranteed. Tomorrow the sun could fail to rise.
Backtesting fits inductive reasoning because it draws probable conclusions about the future from limited past data:
- A trading strategy is hypothesized based on premises.
- The strategy is backtested on historical data.
- If the backtest shows the strategy was profitable in the past, we induce that it will likely be profitable in the future.
However, this conclusion is not guaranteed or certain - the future may differ from the past. So backtesting supports inductive conclusions, unlike deductive reasoning which gives definitive conclusions. The premises alone do not guarantee the strategy will work, we need to gather evidence from data.