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[amibroker] Re: Optimization -- again



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Very informative, especially the last paragraph, which is what I feel 
most people, especially new traders such as myself, end up doing 
unknowingly.

Could you please elaborate further on following? Do you mean a number 
here or something else?

> First, before any modeling begins.  Using judgment of management and
> comparison of trading profiles of many trading runs (real, 
simulated, or
> imagined), pick an objective function by which the "goodness" of a 
trading
> system will be measured.  This is important, it is a personal or 
corporate
> judgment, and it should not be subject to optimization.  

Thanks.

Jitu

--- In amibroker@xxxxxxxxxxxxxxx, "Howard Bandy" <howardbandy@xxxx> 
wrote:
> Greetings --
> 
> In my opinion, anything we do in development of trading systems 
involves a
> search for a pattern than precedes a profitable trading 
opportunity.  Any
> time we examine the results of alternative systems, we are involved 
in
> searching; and when we select the most promising of those 
alternatives, we
> are optimizing.  Only a system based on truly random entries and 
exits would
> not be the result some optimization.  So the question of "should we
> optimize?" is moot -- we have no choice but to optimize.  
Consequently, we
> should be aware of our optimization techniques.
> 
> Chuck referred to an optimization technique recommendation I made 
to the
> company we both worked for in Denver a few years ago.  This is a 
short
> description of it.
> 
> The company is a Commodity Trading Advisor which traded futures, not
> individual stocks, but the procedures are equally valid for both.
> 
> When I joined the company, they were using very long data series 
when
> developing their models.  They used a technique sometimes called 
folding or
> jackknifing, where the data was divided into several periods -- say 
ten.
> The modeling process made ten passes.  During each pass, one period 
was held
> back to be used as out-of-sample data, the other nine were used to 
select
> the best parameter values.  After all ten passes, the results were 
gathered
> together and the parameter values that scored best overall were 
chosen.
> There are several problems with this method.  One is the difficulty 
with the
> "ramp up" period at the start of each segment, another is that it 
is not
> valid to use older data for out-of-sample testing than was used for
> in-sample development, and another is that the data series were too 
long.
> Chuck and I and others had many interesting discussions about how 
long the
> in-sample data should be.  
> 
> My background is strong in both the theory and the practice of 
modeling and
> simulation, and includes a great deal of experience with analysis of
> financial time series.  I proposed the following method, which I 
continue to
> believe is valid.
> 
> First, before any modeling begins.  Using judgment of management and
> comparison of trading profiles of many trading runs (real, 
simulated, or
> imagined), pick an objective function by which the "goodness" of a 
trading
> system will be measured.  This is important, it is a personal or 
corporate
> judgment, and it should not be subject to optimization.  
> 
> Divide each data series into a sequence of in-sample and out-of-
sample
> periods.  The length of the out-of-sample period is 
the "reoptimization"
> period.  Say there are about ten years of historical data available
> (1/1/1993 through 1/1/2003.  Set the in-sample period to two years 
and the
> out-of-sample period to one year.  Run the following sequence:  
Search /
> optimize using 1993 and 1994; pick the "best" model for 1993-1994; 
forward
> test this model for 1995 and save the results; step forward one
> reoptimization period and repeat until all the full in-sample 
periods have
> been used.  The final optimization will have been 2001 and 2002, 
with no
> out-of-sample data to test.  Ignore all in-sample results!!  
Examine the
> concatenated out-of-sample equity curve.  If it is acceptable, you 
have some
> confidence that the parameters select by the final optimization 
(2001 and
> 2002) will be profitable for 2003.  No guarantees -- only some 
confidence.
> 
> How did I pick two years for in-sample and one year for out-of-
sample?  That
> was just an example.  The method is to set up an automated search 
where the
> length of the in-sample period and the length of the out-of-sample 
period --
> the reoptimization period -- are variables, and then search through 
that
> space.  
> 
> Trading systems work because they identify inefficiencies in 
markets.  Every
> profitable trade reduces the inefficiency until, finally, the 
trading system
> cannot overcome the frictional forces of commission and slippage.  
This is
> the same phenomenon that physicists talk about as entropy.
> 
> My feeling -- and it may be different than Chuck's -- is that the 
market is
> not only non-stationary, but that the probability that it will 
return to a
> previous state is near zero.  
> 
> Being non-stationary means that market conditions change with 
respect to our
> trading systems.  If I am modeling a physical process, such as a 
chemical
> reaction, I can count on a predictable modelable output for a given 
set of
> inputs.  If I am modeling a financial time series, the output 
following a
> given set of inputs changes over time.  If a market were stationary 
with
> respect to an RSI oscillator system, I could always buy a rise of 
the RSI
> through the 20 percent line, to use a very simplistic example. 
> 
> I feel that the introduction of microcomputers, trading system 
development
> software, inexpensive individual brokerage accounts, and discussion 
groups
> such as this one have permanently changed the realm of trading.  
One,
> everyone who is interested can afford to buy a computer, run 
AmiBroker, and
> design and test trading systems.  Two, if someone develops a 
profitable
> system and trades it, the profits it takes reduce the potential 
profits
> available to anyone else who trades it.  Consequently, the 
characteristics
> of the market change in a way that moves the market away from that 
model
> until that trading system is no longer profitable enough to overcome
> commission and slippage.  Three, a new person beginning to study 
trading
> system development typically tests a lot of old systems.  If one is 
found to
> be profitable and they start trading it, the market moves back to 
being
> efficient.  Consequently, trading systems that used to work, but no 
longer
> work, are very unlikely to ever work again.
> 
> So, I feel that the in-sample period should be short so that the 
market
> conditions do not change much over that period.  That is, I am 
looking for a
> data series that is stationary relative to my model.  The stationary
> relationship must extend beyond the in-sample period far enough 
that the
> model will be profitable when used for trading in the out-of-sample 
data.
> The length of the extension determines the reoptimization period.  
It could
> be years, months, or even one day.  Note that the holding period of 
a
> typical trade is very much related to the length of both the in-
sample and
> out-of-sample periods.  The typical trade should be much shorter 
than the
> in-sample period and somewhat shorter than the out-of-sample period.
> 
> The important point in all this is that the only results being 
analyzed are
> the concatenated out-of-sample trades.
> 
> As with all model development, every time I look at the out-of-
sample
> results in any way, I reduce the probability that future trading 
results
> will be profitable.  That means that I should not perform thousands 
of tests
> of model parameters, in-sample periods, and out-of-sample periods, 
on the
> same data series and then pick the best model base on my 
examination of
> thousands of out-of-sample results.  In effect, I will have just 
converted
> all those out-of-sample results into in-sample data for another 
step in the
> development.  That is legitimate, just be aware of what is 
happening.
> 
> Thanks for listening,
> Howard


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