Archive for the ‘Allegory’ Category

Black Box Chronicles: a Conversation with Optimization

September 14, 2009

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.

Black Box Chronicles – Getting Lost

August 28, 2009

I’m trapped inside a black box. I know, I was warned not to come here in the first place, told my best option was to keep it simple: trade the probabilities, let your winners run and limit your losses. It started as a simple glance, really. Then a gaze and then I took the first step into the black box. Now, I don’t know how to get out. Don’t be alarmed, I’m comfortable here. The people (creatures, really) are pretty nice so far. But I need to leave here at some point because from everyone I’ve spoken to, you can’t trade while you’re in the black box. That seems patently absurd to me since the black box is system trading, and ‘trading’ is part of system trading. Right now though, I’m not in the mood to argue. There’s some pretty cool stuff in here and interesting creatures roaming about that I’ve got to bring out.

For starters, there is enough gold in here that if I could just get a small fraction of it out, and the price of gold went to zero, I’d still be rich. I’ll worry about that later. Let me first relate the conditions surrounding my entrapment.

It started when I decided to leave the world of discretionary trading. That was a tough choice, but sometimes defining moments present themselves to you and you simply need to do what it takes to define yourself. Almost by default, system trading was the last method standing. So that’s the path I took. With system trading, I must warn you now, once you start poking around it doesn’t take long to follow so many winding paths that you can’t remember how to get back out. That’s what happened to me. My pursuit of system trading has led me into the trader’s black box. Trust me, it’s a lot more than a group of algorithms. I feel lost now, but at the same time I feel like I’m at home.

The first creature I came upon in the black box is a curious fellow. He’s a nice little man that reminds me of Yoda. I couldn’t figure out at first if he’s the janitor or actually runs the place. I’m still not sure.

So I asked him,’What is this place?’

He replied ‘It’s a black box.’

‘As in a trading black box?’

‘Yes,’ he says.

‘Where can I go to place a trade then?’ I’m feeling a little giddy at this point, like I’ve arrived by default in trader’s nirvana.

‘You can’t place a trade while you’re in the box,’ he says.

Not the answer I was expecting. It’s called system trading. And black box or no black box, there is trading in system trading.

‘Fine,’ I said, ‘then can you direct me how to get out of here?’

‘You don’t ever get out of the black box once you’ve entered it. You have to become the box.’

More bad and unexpected news. The song ‘Hotel California’ starts looping in my brain. But between you and me, I think he’s just the janitor.

I decided to keep exploring and leave this nice little man alone for awhile. So far, I’ve met many old friends whom I’ve never met in person before. Simple Moving Average is here, as is RSI, MACD and even Head&Shoulders (he’s a big fella, as one would expect). There are also these little furry balls that run around the place screaming “got to find the best parameter” in a soft, squeaky voices. They call them swarming bots. I’d like to kick one across the room, quite frankly.

I also ran into ADX. He was kind of bummed out telling me how it’s hard for him to get work lately. I promised him I’d send some work his way once I got out of the box.

Curiously, he told me the same thing as that nice little man. ‘You can’t leave the box.’

I’ll attribute that to the medication he’s obviously taking. You see, contrary to popular trading myth, there actually is emotion in the black box.

There is so much to explore in here, I’m cool with hanging out for a while. For instance, I’ve always wondered what the deal was with Fuzzy Logic. I just saw him pass by and he’s on my list of people to interview.

Yes, I realize that one can spend too much time exploring every possible trading method and form of technical analysis. After all, traders trade. We’re not perpetual students of methodologies. But since I can’t figure how to get out of this place at the moment anyway, why not spend some time enjoying myself?

On my list of places/people to see while I’m trapped in here.

1. Genetic Algorithms
2. Particle Swarm
3. Intermarket Correlation
4. Visual Basic and C# programming
5. Statistics
6. Neural Network
7. Kernel Regression
8. Fuzzy Logic

And that’s about it. After that, I’ll commit to getting out of here. I’m not too concerned about it, really. These walls are sort of fluffy. And the air is refreshingly crisp.