Stock market bayesian theory

One of the most important notions in probability and statistics is Bayes' Theorem, and it can be a little difficult to understand. It involves negotiating probabilities of conditional events to find out what is really going on. In his new book, The Signal and the Noise , FiveThirtyEight 's founder Nate Silver gives the single most coherent explanation of Bayes' Theorem out there.

Suppose you are living with a partner and come home from a business trip to discover a strange pair of underwear in your dresser drawer. You will probably ask yourself: The first, "y" is the probability that the underwear appeared because you are in fact being cheated on. If he's cheating on you, it's certainly easy enough to imagine how the panties got there.

Bayes' Theorem Can Make You a Better Investor

Then again, even and perhaps especially if he is cheating on you, might expect him to be more careful. Let's say the probability of the panties appearing, conditional on him cheating on you, is 50 percent. Next, you want to estimate "z," the probability that the underwear appears but he's not cheating on you - maybe they're a gift, or a platonic female friend stayed over and left them, or there was a luggage mix up.

Finally, you need to figure out the prior probability, or "x". This is the probability that, had you not found the underwear, you think your partner is cheating on you. Studies have found, for instance, that around 4 percent of married partners cheat on their spouses in any given year, so we'll set that as our prior.

Bayes theorem computes the posterior probability, or the probability that, given you found the underwear, your spouse is cheating. The book goes back to Bayes' theorem constantly, and for excellent reasons - it's an exceptionally powerful way to honestly gauge a complex reality based on estimable probabilities, and is perhaps the most important theory in modern probability.

The Signal and the Noise is available starting September 27th. Tech market is nowhere near the dotcom days. How augmented reality is changing the way we work.

You are using an outdated version of Internet Explorer. For security reasons you should upgrade your browser. Please go to Windows Updates and install the latest version.

Trending Tech Insider Finance Politics Strategy Life Sports Video All.

What Causes The Stock Markets

You have successfully emailed the post. Nate Silver Explains The Most Important Concept In Statistics.

Here's how it goes: Nate Silver Math Statistics. Recommended For You Powered by Sailthru. Nate Silver Explains The Most Important Concept In Statistics Nate Silver Explains The Most Important Concept In Statistics If you don't completely understand Bayes' Theorem, you don't understand probability.

Thanks to our partners. Registration on or use of this site constitutes acceptance of our Terms of Service and Privacy Policy.

Disclaimer Commerce Policy Made in NYC. Stock quotes by finanzen.