Evaluating the Fitness of a Fitness Function

November 9, 2009

The walk-forward process of system development is the final test of a system before real capital gets allocated. It validates the system on out-sample data, or data that hasn’t been peeked at during development. It’s not very complicated, really. You optimize your system on a range of data and then choose the best parameter set to trade with in the out-sample period. Then you observe the results and determine if the system warrants any capital investment. As with most things in system trading, you need to make a decision on how you approach this idea of picking the best parameter set. Who or what decides what is best? The arbiter is known as a fitness function, because it determines which parameter set is best suited for future trading. Not all fitness functions are created equal though. Let’s look at three fitness functions and see how they offer different results. Read the rest of this entry »

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A Short List of Candidates

November 6, 2009

You can’t trade everything. Well, at least you can’t trade everything well. At some point, you should limit the universe of things you trade. And it’s okay. You don’t need to trade everything because quite frankly, nobody knows what you’re talking about anyway at the weekend cocktail party, and they don’t care. I implore you to be prudent in this way: commit to trading a specific world of underlyings, and quit chasing bright lights in the depths of the ocean, like everyone’s favorite Nemo character, Dory the Blue Tang. Read the rest of this entry »

Long R, Short Excel

October 29, 2009

R is very speedy statistical package that’s like an F-18A Hornet, versus Excel which is like a paper airplane. R is professional sports, Excel is Pop Warner. R is Mona Lisa, Excel is stick figures. R is … okay, you get the idea. I’m long R, and short Excel. For traders that are analyzing vasts amount of data, it’s time you made the switch to the trader’s statistical package of choice. You have to work a little at understanding the scripting language, but it’s nothing that you can’t wrap your mind around in a few nights after the kids go to bed. I’m just getting acquainted with R, and I’m already putting my copy of Excel on eBay. Read the rest of this entry »

System Trading is Quicksand without the Quick

October 28, 2009

Perhaps the best way to describe the path to system trading is slogging. It’s like one of those dreams where you’re trying to run in the sand, and it keeps sinking. And then it starts to rain and the wind starts blowing you backwards. Like many things related to trading, system trading sounds simple on its face, but becomes increasingly elusive as one pursues it. Read the rest of this entry »

Is your equity curve underwater this year?

October 9, 2009

Is your equity curve underwater so far this year? Okay, you may be a loser, but you can still sing a very fine tune. It’s not the same as singing joyfully and proudly about your ability to follow a trend, but it’s close.

Are you related to Perfect Profit?

October 9, 2009

Okay, by now you’ve probably discovered you are not the perfect trader. You are but a fraction (if that) of the money-banking machine. He is no longer your friend, this creature known as Perfect Profit is your competition. Now that you’ve formally met your competition, what is the family resemblance between your equity curve and Perfect Profit’s equity curve? Are you brother and sister, second cousins or do you need to go all the way back to Tiktaalik roseae to find a common gene? On the practical level, what is the correlation between your equity curve and Perfect Profit’s equity curve? Read the rest of this entry »

How close are you to perfect?

October 8, 2009

Becoming the perfect trader is no easy task, and I daresay that nobody has been able to achieve this great feat. The perfect trader buys at the absolute low of the day and sells at the absolute high. And depending on whether the high happens first or the low happens first determines if he is long or short for the day. It’s really easy to calculate this metric. It is simply the absolute value of the daily range or the high minus the low. Read the rest of this entry »

Rusty Apple

October 2, 2009

The main objective of system trading is to create a trade system that has predictive value and can make money for years to come. If a system historically doesn’t make money, it’s not worth pursuing. Or is it? In the curious world of trade system development, some have stumbled upon good trading systems by fading their original idea, which performed so abysmally that you couldn’t lose that much money unless you started throwing it out the window as fast as you can. System trading can also provide other insights into market behavior that, if not yielding a tradeable system, can at least give you some ideas about developing one. From the twitter world, I got the following idea from AshRust: How about each time the VIX spikes X% buy AAPL, then sell after 5/15/30 days w/ 10% stop loss? It’s an interesting idea that’s contrarian and uses intermarket analysis to trigger a long trade. Does it work? Can you trade it? Or is it nothing more than a curious data-mined notion? Read the rest of this entry »

Goodbye Bumblebee, Hello Ladybug

September 25, 2009

I had grand schemes and lofty goals for the Bumblebee system. But barring an egregious mistake in my walk-forward of the system, I have to let the critter go. The White Bumblebee (first version) suffered massively in its synthetic real-world experience, like a patient etherised on the table only to suffer reality’s cruel but necessary knife. I had other versions queued up and ready to improve upon the simplest version, but they did no better in their walk-forwards. Not to worry, there are many more insects in the hopper. Next one sprawling on a pin is the Ladybug. It is based on Keltner band breakouts. Keltner bands are like Bollinger bands, but they’re based on ATR instead of standard deviation. The basic idea is that once the band is breached, take a trade in the direction of the excursion and enjoy great inflows of capital into your account. Read the rest of this entry »

Trade your Equity Curve

September 24, 2009

System traders understand that their approach to trading requires nerves-of-steel patience while in a drawdown, gut-wrenching discipline in taking every signal generated by the system (and I mean every signal – no ifs, ands, buts or maybes) and cat-like reflexes in executing signaled trades before doubt can creep into the kernel regressing, quadratic equation. Whoever said that system trading takes the emotions out of trading doesn’t know the half of it. Doubters and skeptics of system trading recite the ‘past performance doesn’t guarantee blah, blah, blah’ mantra, refer to the perils of overfitting and data mining, and express a general independence from the enslaving nature of system trading. Well, you’ll be happy to know that you can be a system trader and not take every trade. How? Trade your equity curve. Read the rest of this entry »