Black Box Chronicles: a Conversation with Optimization

I’m having the most pleasant conversation with Optimization over a couple of espressos and biscotti when this hideous creature walks into the room. The she-devil says she has to talk with Optimization in private, so I muddle over to the counter to get two more espressos. But I’m listening carefully. There are threats being volleyed back and forth and some talk about children. The creature leaves and I saunter back to the table with fresh espressos in hand. Curious about the creature, I ask my new friend what that exchange was all about.

‘Who was that?’ I ask.

‘She likes to call herself Optimal, but I call her Overfit.’

Sounds like the perfect description of an ex. I come to find out that Overfit is a mistress of my new friend Optimization. And apparently, they have lots of children together. Optimization is caught in this relationship, and he can’t get out of it. It’s just one of those things.

‘Now, back to my main point,’ Optimization continues.

He gets back into his rant about how it’s not his primary job to find the optimal parameters of a trading system, but rather to test how sturdy a strategy really is.

‘There are really a very wide range of parameters any decent trader can pick from a very wide range of objectives. I offer much more than giving you a dream set. I can tell you if your system has the cajones to trade in future.’

I explain to Optimization that I get it. I also remind him that his job is to find optimal parameters, but also acknowledging that he needs good direction on what to look for from the trader.

‘I can find best parameters based on a variety of measurements,’ he says, ‘I can tell you what the best parameters are based on net profit, net profit/maximum drawdown or some other more clever measurements.’

‘How fond are you of finding best parameters based on net profit,’ I ask. It’s kind of a trick question on my part, really. I realize this isn’t the best way to measure the potential for future profits, but I’d like to hear his take on this.

His eyes start fluttering and he puts down his espresso, almost as a measure to ensure he has nothing to throw at the wall.

‘I don’t like that method, quite frankly.’

I’m about to leave it at that and then he starts in about Overfit.

‘You know that I have certain relationships that I cannot justify to you. Let me be clear, the best way to lead me into my own circle of hell is to ask me to give you the best parameters based on past net profit.’

Okay. Time to change the subject. Clearly not a favorite topic and a little awkward. Just as I try to switch the discussion over to clever fitness functions, in walks a very strange creature named Data Mining.

I wish I could properly describe the look on Optimization’s face when he saw that thing come into the cafe. It was sheer horror that looked comical at the same time.

Data Mining is the albatross around Optimization’s fragile neck. When traders deploy this creature, they are basically torturing Optimization to the core. Data Mining is most annoying even to the uninvolved observer. He mumbles nonsense and has a queer look of promise on his face, not unlike your favorite purveyor of useless kitchen gadgets. As the little troll came into the room, I could hear him repeating a phrase that was barely audible.

‘The chance that the S&P 500 will be up for the year is directly correlated to how many players in the World Series for that year have last names that start with the letter A through M. If most of the players have last names beginning with N through Z, expect a down year.’

‘Is that true?’ I ask Optimization.

‘Probably, but let’s not go there for now.’

I can see how tortured a soul Optimization really is. He is very much a nice fellow should you ever meet him. But he is plagued in the Box. He is an indentured servant to the trader and though he doesn’t always like or agree with what he is made to do, he performs regardless.

I’m starting to see that the Box is not only filled with interesting creatures, but ominous ones as well. I will tread lightly as a precaution.

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