heoretical excursion

Optimisation can be your best friend but also your worst enemy when you develop
a
trading system. The important point is that you always know what you are doing w
hen
you vary some of the systems input parameters. Keep in mind that every trading sy
stem
is in some form an optimisation. When you select a system you compare it with ot
hers
and choose it because it has shown a special behaviour in the past which convinc
es you
that this special behaviour will hold in the future. Even if you do not adjust a
ny of its
input parameters, in rejecting other, maybe similar, trading systems you have es
sentially
done this by optimising the input parameters afterwards with your computer.
The open question remains: at which point does the development and selection pha
se of
a system end and the optimisation of your system start? Since it can never be co
mpletely
separated, it is better to accept that every trading system is in some way an ad
aptation of
the past and therefore is optimised. So the key question for you as a system dev
eloper is
always: which parameter do you choose from your back-tests? Which settings are l
ikely
to continue to produce profits in the future in real trading? The answer to this
question is
different for each trading system but one rule holds true for all: the neighbour
hood of
your chosen system parameters must be nearly as profitable as your chosen system
parameter and the bigger this profitable parameter range is the better. Murray R
uggiero,
an experienced professional trading systems developer, writes about this topic [
7]:
If you dont like the neighbouring numbers, youve got a problem, because odds
are, you will wind up with the results of the neighbouring set of parameters.
49Trading Systems
Lets have a look at an example (Figure 3.4) where we examine the hypothetical res
ults
of an imaginary system in order to select stable input parameters. On the right
axis you
find one input parameter of this hypothetic system which can be anything, a movi
ng
average, a distance of a stop or a profit target, a delay time etc. As a functio
n of this
system parameter you find on the vertical axis the net profit in arbitrary units
.
The best input parameter of this artificial trading system in terms of net profi
t would be
17. With this parameter the system gained 80,000 units. But look at its neighbou
rhood.
In the next neighbourhood, with parameter 16, the systems profit is very poor (50
00
units) or with parameter 18 there is even a loss (-10,000 u