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Trading Systems

A trading document

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Tommy Anderson
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Available Formats
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100% found this document useful (3 votes)
2K views

Trading Systems

A trading document

Uploaded by

Tommy Anderson
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PDF, TXT or read online on Scribd
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TRADING SYSTEMS

A new approach to system development and portfolio optimisation

Urban Jaekle Emilio Tomasini


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Trading Systems
A new approach to system development and portfolio optimisation

Emilio Tomasini & Urban Jaekle

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Contents
Acknowledgments Preface x xi

Part I: A Practical Guide to Trading System Development and Evaluation


Chapter 1: What is a trading system?
1.1 An easy example of a trading system 1.2 Why you need a trading system 1.3 The science of trading systems

1
3
4 5 7

Chapter 2: Design, test, optimisation and evaluation of a trading system


2.1 Design Getting started The programming task Which timeframe to trade? 2.2 Test The importance of the market data The length of your back-testing period Rule complexity and degrees of freedom 2.3 The forecasting power of a trading system Optimisation Walk forward analysis Robustness 2.4 Evaluation of a trading system What to look for in an indicator Average trade Percentage of profitable trades

9
9 9 10 11 12 12 14 15 19 19 21 23 27 27 28 28

iii

Trading Systems

Profit factor Drawdown Time averages RINA Index 2.5 Conclusion

30 30 31 32 33

Part II: Trading System Development and Evaluation of a Real Case


Chapter 3: How to develop a trading system step-by-step using the example of the British pound/US dollar pair
Introduction 3.1 The birth of a trading system The free LUXOR system code The entry logic 3.2 First evaluation of the trading system Calculation without slippage and commissions Calculation after adding slippage and commissions 3.3 Variation of the input parameters: optimisation and stability diagrams What does stability of a systems input parameter mean? A short theoretical excursion Dependency of main system figures on the two moving averages Result with optimised input values 3.4 Inserting an intraday time filter Finding the best entry time Result with added time filter 3.5 Determination of appropriate exits risk management The concept of Maximum Adverse Excursion (MAE) Inserting a risk stop loss Adding a trailing stop Looking for profit targets: Maximum Favorable Excursion (MFE)

35
37
37 38 39 41 43 43 47 49 49 51 56 59 59 61 64 66 70 74 76

iv

Contents

Summary: Result of the entry logic with the three added exits How exits are affected by money management 3.6 Summary: Step-by-step development of a trading system

79 83 86

Chapter 4: Two methods for evaluating the systems predictive power


4.1 Timescale analysis Changing the compression of the price data LUXOR tested on different bar compressions Net profit and maximum drawdown dependent on the traded bar length Explanation for the time dependency of the system 4.2 Monte Carlo analysis The principle of Monte Carlo analysis Exchanging the order of the performed trades Probabilities and confidence levels Performing a Monte Carlo analysis with the LUXOR trading system Limitations of the Monte Carlo method

89
90 90 92 96 97 101 101 104 105 107 108

Chapter 5: The factors around your system


5.1 The markets long/short bias The trend is your friend? Consequences for system development 5.2 Out-of-sample deterioration A Bollinger Band system with logic and code Optimising the Bollinger Band system Out-of-sample result Reasons for the out-of-sample deterioration 5.3 The market data bias Expanding the training period Conclusion: How to choose your training data

111
112 112 114 115 115 118 119 121 122 122 126

Trading Systems

5.4 Optimisation and over-fitting Step-by-step optimisation of the LUXOR system Results depending on the number of optimised parameters The meaning of the trading systems complexity 5.5 Rule complexity explained with polynomial curve fitting Interpolating data points with polynomial functions Predictive power of the different polynomials Conclusions for trading system development

126 126 127 134 136 136 142 145

Chapter 6: Periodic re-optimisation and walk forward analysis


6.1 Short repetition: normal, static optimisation 6.2 Anchored vs. rolling walk forward analysis (WFA) 6.3 Rolling WFA on the LUXOR system Periodic optimisation of the two main system parameters Out-of-sample test result Conclusion 6.4 The meaning of sample size and market structure

147
147 149 150 150 153 155 155

Chapter 7: Position sizing example, using the LUXOR system


7.1 Definitions: money management vs. risk management Risk management (RM) Money management (MM) 7.2 Application of different MM schemes Reference: The system traded with one lot Maximum drawdown MM Fixed fractional MM Fixed ratio MM 7.3 Monte Carlo analysis of the position sized system 7.4 Conclusion

159
159 159 160 161 162 163 164 168 173 175

vi

Contents

Part III: Systematic Portfolio Trading


Chapter 8: Dynamic portfolio construction
8.1 Introduction to portfolio construction A list of the main available software The role of correlations Publications and theoretical tools Portfolio trading in practice Total vs. partial equity contribution 8.2 Correlation among equity lines 8.3 A dynamic approach: equity line crossover

177
179
179 180 181 182 183 185 186 188

8.4 Dynamic portfolio composition: the walk forward analysis activator 190 8.5 Largest losing trade/largest losing streak/largest drawdown 192

Conclusion Appendices: Systems and ideas


Appendix 1: Bollinger Band system
1.1 Idea 1.2 Entry logic and Easy Language code 1.3 Application of the strategy to seven markets with same parameters 1.4 Results and conclusions

193 199
201
201 202 204 204

Appendix 2: The Triangle system


2.1 Idea 2.2 Programming and coding 2.3 Application to different liquid futures markets with same parameters 2.4 Advantages in building a portfolio 2.5 Conclusion

209
209 210 211 212 212

vii

Trading Systems

Appendix 3: Portfolios with the LUXOR trading system


3.1 Idea 3.2 The trading logic 3.3 Results in the bond markets 3.4 Diversification with other market groups 3.5 Conclusion

221
221 223 223 224 225

Bibliography Index

235 237

viii

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Preface
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xi

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xii

Part I:
A Practical Guide to Trading System Development and Evaluation

1
What is a trading system?
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Trading Systems

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1.1 An easy example of a trading system


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What is a trading system?

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1.2 Why you need a trading system


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Trading Systems

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What is a trading system?

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1.3 The science of trading systems


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Trading Systems

/H M><AGB<:E :G:ERLBL, NMBEBLBG@ MA> MHHEL H? LM:MBLMB<:E BG?>K>G<>, LM:KML ?KHF : L:FIE> H? H;L>KO:MBHGL BG HK=>K MH @:N@> LHF> LM:MBLMB<:E IKHI>KMB>L H? MA> PAHE> IHINE:MBHG. %G MABL P:R M><AGB<:E :G:ERLBL, EBD> LM:MBLMB<L, BL JN:GMBM:MBO>. "NKMA>K, M><AGB<:E :G:ERLBL, EBD> L<B>G<>, MKB>L MH IK>=B<M MA> ?NMNK> MAKHN@A ?NG<MBHG:E K>E:MBHGLABIL :FHG@ O:KB:;E>L. %? MABL O:KB:;E> =H>L MABL MA>G MA> =>I>G=>GM O:KB:;E> PBEE =H MA:M. 3A:M BG M><AGB<:E :G:ERLBL BL : KNE> BG LM:MBLMB<L BL : ?NG<MBHG:E K>E:MBHGLABI, PAB<A : <>KM:BG IKH;:;BEBMR BL :MM:<A>= MH. 0A>K> BL GH ;:KKB>K ;>MP>>G L<B>GMB?B< M><AGB<:E :G:ERLBL :G= LM:MBLMB<L LH MA:M :EE MA> =HN;ML K:BL>= ;R MAHL> MA:M =BLEBD> LN;C><MBO> M><AGB<:E :G:ERLBL LN==>GER =BL:II>:K. -N:GMBM:MBO> M><AGB<:E :G:ERLBL NL>L MA> MRIB<:E F>MAH= H? :G:ERLBL BG :IIEB>= L<B>G<>L: MA> ARIHMA>MB<-=>=N<MBO> F>MAH= BGBMB:M>= ;R *>PMHG :G= F:=> ?:FHNL ;R ,HII>K. 0A> ARIHMA>MB<-=>=N<MBO> F>MAH= A:L ?BO> LM:@>L 728: 1. Ob,e+/a-"('. 0A> LRLM>F =>O>EHI>K, MAKHN@A MA> <HGMBGNHNL H;L>KO:MBHG H? MA> =:BER :G= BGMK:=:R :<MBOBMR H? MA> ?BG:G<B:E F:KD>ML, =>OBL>L : K>E:MBHGLABI :FHG@ O:KB:;E>L, B.>. :FHG@ MA> =:BER OHENF> :<MBOBMR :G= MA> <EHLBG@ IKB<>, HK :FHG@ MA> O:EN> H? :G BG=B<:MHK :G= MA> G>QM =:R HI>GBG@. H2)(-!e,",. 0ABL <HF>L ?KHF MA> BGGHO:MBO> FBG= H? MA> LRLM>F =>O>EHI>K W :G BGM>EE><MN:E LI:KD, MA> HKB@BGL H? PAB<A GH;H=R DGHPL. 0A> LRLM>F =>O>EHI>K NG=>KLM:G=L MA:M MA> K>E:MBHGLABI A> ARIHMA>LBL>L BL GHM =N> ;R <A:G<> MH MA> I:KMB<NE:K G:MNK> H? MA> L:FIE> A> :G:ERL>=, ;NM BM BL <HFFHG MH MA> F:CHKBMR H? MA> L:FIE>L A> <:G =>=N<M ?KHF MA> PAHE> IHINE:MBHG H? =:M:. P+ed"c-"('. %? MA> K>E:MBHGLABI BL MKN> MA>G : <HG=BMBHG:E IKHIHLBMBHG HK : IK>=B<MBHG <:G ;> <HGLMKN<M>= :G= ZMA> IK>=B<MBHG M>EEL NL PA:M LAHNE= ;> H;L>KO>= BG : G>P L>M H? H;L>KO:MBHGL B? MA> ARIHMA>LBL BL BG=>>= MKN>[2. Ve+"f"ca-"('. 0A> LRLM>F =>O>EHI>K O>KB?B>L B? MA> IK>=B<MBHG AHE=L MKN> BG : G>P L>M H? H;L>KO:MBHGL. C('c%.,"('. 0A> LRLM>F =>O>EHI>K, MAKHN@A MA> NL> H? LM:MBLMB<:E BG?>K>G<> MHHEL LN<A :L <HG?B=>G<> BGM>KO:EL :G= ARIHMA>LBL M>LML, PBEE =><B=> B? MA> ARIHMA>LBL BL MKN> HK ?:EL> P>B@ABG@ PA>MA>K G>P H;L>KO:MBHGL PBEE <HG?BKF MA> IK>=B<MBHGL.

2.

3.

4. 5.

0ABL IKH<>LL BL BG GH P:R =B??>K>GM ?KHF MA> L<B>GMB?B< :IIK:BL:E F>MAH= NL>= BG :IIEB>= L<B>G<>L EBD> <A>FBLMKR HK ;BHEH@R.

AKHGLHG, :OB=, E*ide#ce-Ba'ed Tech#ica! A#a!,'i', 3BE>R, 2006, L>> 728.

2
Design, test, optimisation and evaluation of a trading system
2.1 Design
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

Getting started
A @HH= IE:<> MH ;>@BG BL MA> >QBLMBG@ EBM>K:MNK> HG :E@HKBMAFB< MK:=BG@: RHN <:G M:D> MA> ;B;EBH@K:IAR H? MABL ;HHD :L : LM:KMBG@ IHBGM. AGHMA>K L>KBHNL LHNK<> H? @HH= MK:=BG@ B=>:L BL MA> M><AGB<:E LI><B:EBL>= IK>LL BG<EN=BG@, :FHG@ HMA>KL: 1. 2. 3. T&ade&' PPP.MK:=>KL-F:@.<H.ND Ac(i*e T&ade& PPP.:<MBO>MK:=>KF:@.<HF F)()&e' PPP.?NMNK>LF:@.<HF

Trading Systems

4. 5.

The Tech#ica! A#a!,'( PPP.M><AGB<:E:G:ERLM.<H.ND Tech#ica! A#a!,'i' $f S($c ' & C$""$di(ie' PPP.MK:=>KL.<HF

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

The programming task


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
10

Design, test, optimisation and evaluation of a trading system

:GHMA>K P:R, GHM >O>G ;K>:MA-M:DBG@ MK:=BG@ LRLM>FL <:G ;><HF> OB:;E> BGO>LMF>GM MHHEL B? :IIKHIKB:M> FHG>R :G= KBLD F:G:@>F>GM MHHEL :K> GHM :IIEB>=.

Which timeframe to trade?


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

11

Trading Systems

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

2.2 Test

The importance of the market data


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

12

Design, test, optimisation and evaluation of a trading system

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

1. Same expiration contracts


0A> BG=BOB=N:E <HGMK:<ML :K> <HGG><M>= :<<HK=BG@ MH MA> >QIBK:MBHG FHGMAL. 0A:M BL, ?HK >Q:FIE>, RHN <HGG><M />IM>F;>K CHKG 2001 PBMA />IM>F;>K CHKG 2002 :G= />IM>F;>K CHKG 2003 :G= LH HG. 0ABL :IIKH:<A BL IHLLB;E> PA>K> >O>KR LBG@E> >QIBK:MBHG FHGMA @H>L <EHL> MH BML I>>K ?HKMA<HFBG@ >QIBK:MBHG FHGMA, MA> <EHL>K MA> ;>MM>K, :G= BM BL ;>LM PA>G BM HO>KE:IL MA> ?HKMA<HFBG@ <HGMK:<M ;R LHF> FHGMAL :L BG MA> <:L> PBMA <>K>:E F:KD>ML. /NK>ER MABL :IIKH:<A BL GHM IHLLB;E> HG : LMH<D BG=>Q MA:M NLN:EER E:LML MAK>> FHGMAL HK HG :G >G>K@R ?NMNK>L BG=>Q MA:M NLN:EER E:LML HG> FHGMA. +G <HFFH=BMB>L MA:M A:O> : L>:LHG:E LMH<DBG@ BG=NLMKR MA:M ;KBG@L MA> NG<HGLNF>= IKH=N<MBHG HG : @BO>G R>:K MH MA> ?HEEHPBG@ HG>, IKB<>L M>G= MH :LLNF> : LBFBE:K I:MM>KG :<<HK=BG@ MH MA> >QIBK:MBHG FHGMAL. 3BMA 1/ <HKG, ?HK >Q:FIE>, PAB<A BL A:KO>LM>= ?KHF />IM>F;>K MH +<MH;>K, MA> L:F> IE:R>KL :K> BGOHEO>= (?:KF>KL, LMH<DBG@ BG=NLMKR >GMK>IK>G>NKL, <:MME> ;K>>=>KL, >M<) HG MA> />IM>F;>K >QIBK:MBHG <HGMK:<M >:<A R>:K :G= LH MA>R M>G= MH :LLNF> MA> L:F> ;>A:OBHNK:E I:MM>KG. %G HMA>K M>KFL BM BL FHK> IKHI>K MH <K>:M> : IKB<> L>KB>L PBMA :EE MA> />IM>F;>K >QIBK:MBHG FHGMAL <HGG><M>= MH@>MA>K MA:G : <HGMBGNHNL HK I>KI>MN:E IKB<> L>KB>L MA:M FBQ>L NI =B??>K>GM =>EBO>KR FHGMAL MA:M A:O> GHMABG@ BG <HFFHG.

13

Trading Systems

2. Continuous contracts
0A> <HGMBGNHNL <HGMK:<M BL :G :KMB?B<B:E X<HEE:@>Y H? MA> =B??>K>GM ?HKMA<HFBG@ =>EBO>KR FHGMAL. 0A> K:MBHG:E> H? MA> <HGMBGNHNL <HGMK:<M BL MA:M MA> ?HKMA<HFBG@ <HGMK:<M BL MA> FHLM EBJNB= :G= MA> FHLM MK:=>= LH MA:M B? RHN :== NI :EE MA> ?HKMA<HFBG@ <HGMK:<ML RHN PBEE A:O> : LB@GB?B<:GM IKB<> L>KB>L. 0A> IKH;E>F BL MA:M HG MA> =>EBO>KR =:R RHN PBEE A:O> : @:I ;>MP>>G MA> HE= >QIBK:MBHG FHGMA :G= MA> G>P HG>. 0ABL @:I BL PA:M A:II>GL BG K>:EBMR PA>G RHN :K> MK:=BG@ K>:E FHG>R. %? RHN :K> BG : MK:=> :G= RHN G>>= MH LPBM<A MH MA> LN<<>LLBO> <HGMK:<M ;>?HK> MA> =>EBO>KR =:R H? MA> >QIBK:MBHG <HGMK:<M RHN PBEE :== NI HK LN;MK:<M MA> =B??>K>G<> BG IKB<>L HG MA> >QIBK:MBHG =:R ?KHF MA> >O>GMN:E K>LNEM H? MA> MK:=>.

3. Perpetual contracts
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

The length of your back-testing period


(BM>K:MNK> IHBGML MH MA> ?:<M MA:M : MK:=BG@ LRLM>F, BG HK=>K MH ;> KH;NLM :G= <HGLBLM>GM, FNLM ;> FHK> HK E>LL LN<<>LL?NE HG : FNEMB-I>KBH= FNEMB-F:KD>M M>LM. 0ABL BL :G BFIHKM:GM IHBGM MA:M, PBMA MA> G>P>LM @>G>K:MBHG H? <HFINM>KL, A:L ;>>G INM NG=>K L<KNMBGR MA:GDL MH MA> ?:LM LI>>= H? F:DBG@ <:E<NE:MBHGL :G= <A>:I :O:BE:;BEBMR H? ABLMHKB<:E IKB<> L>KB>L. A<<HK=BG@ MH LHF> F><A:GB<:E MK:=>KL MA> FNEMB-F:KD>M KNE> LAHNE= ;> EBFBM>= LBG<> LRLM>FL A:O> MA>BK HPG I>KLHG:EBMR MA:M LNBML HGER : <>KM:BG ;:M<A H? F:KD>ML ;NM GHM :EE. .:K> :K> MA> LRLM>FL MA:M <:G PBMALM:G= MA> FNEMB-F:KD>M M>LM BG MA> L>GL> MA:M MA>R PHKD >JN:EER P>EE HG F:GR =B??>K>GM F:KD>ML (;HG=L, >JNBMR, <HFFH=BMB>L, <NKK>G<B>L, LMH<DL, >M<). 3> LA:K> MA> L:F> HIBGBHG PBMA MA>L> MK:=>KL W :?M>K 20 R>:KL >QI>KB>G<> P> <:G MH=:R <HNGM MA> K>:E FNEMB-F:KD>M LRLM>FL HG MA> ?BG@>KL H? CNLM HG> A:G=.

14

Design, test, optimisation and evaluation of a trading system

CHGO>KL>ER, :L ?:K :L FNEMB-I>KBH= M>LML :K> <HG<>KG>=, HMA>K F><A:GB<:E MK:=>KL IHBGM MH MA> ?:<M MA:M I:LM BL I:LM: F:KD>ML <A:G@> <HGMBGNHNLER ;><:NL> ><HGHFR, BGLMBMNMBHG:E LMKN<MNK> :G= LH<B>MR <A:G@>. /H PAR >QI><M F:KD>ML MH ;>A:O> BG MA> L:F> P:R R>:K :?M>K R>:K? 0A>K> :K> F:GR LRLM>F MK:=>KL MA:M ?HK BGMK:=:R MK:=BG@ LRLM>FL PBEE G>O>K M>LM ;:<D FHK> MA:G 12 FHGMAL :G= HMA>KL PBEE M>LM ;:<D CNLM 3 FHGMAL. 3> PBEE L>> LAHKMER AHP HIMBFBL:MBHG :G= K>-HIMBFBL:MBHG PBEE ?BM BGMH MABL PAHE> IB<MNK>. /H ?:K P> <:G CNLM >QIK>LL HNK IHBGM H? OB>P, PAB<A BL G>BMA>K I>KFBLLBO> GHK LMKB<MER KB@B=. 3> MABGD MA:M MA> E>G@MA H? MA> ;:<D-M>LMBG@ I>KBH= LAHNE= ;> =><B=>= PBMA LHF> HK=BG:KR :<NF>G =>KBO>= ?KHF >QI>KB>G<>. "HK >Q:FIE>, E>M[L <HGLB=>K : ;:GDBG@ LMH<D MA:M MK:=BMBHG:EER A:= : <AHIIR IKB<> L>KB>L. /N==>GER MABL ;:GD F>K@>L PBMA :G HGEBG> ;:GD =NKBG@ MA> 2000 ;N;;E>. %G 2001 BM PHNE= ;> BG:IIKHIKB:M> MH M>LM : LRLM>F HG MA> IKB<> L>KB>L ;>?HK> MA> F>K@>K ;><:NL> BM BL LHF>MABG@ MA:M A:L <A:G@>= LH :;KNIMER. AGHMA>K >Q:FIE> BL PBMA >NKH/=HEE:K. ):GR =:M: IKHOB=>KL H??>K <NLMHF>KL : >NKH/=HEE:K IKB<> L>KB>L =>KBO>=, HK PHKL> >QMK:IHE:M>=, BG LHF> P:R ;>?HK> 2003. +MA>K =:M: O>G=HKL LBFIER >QMK:IHE:M> MA> >NKH/=HEE:K IKB<> L>KB>L ;>?HK> 2003, F:DBG@ : IKHIHKMBHG PBMA MA> >NML<A> F:KD/=HEE:K I:BK. %M BL H;OBHNL MA:M BM PHNE= ;> ?:M:E MH M>LM : LRLM>F HG : >NKH/=HEE:K IKB<> L>KB>L LM:KMBG@ ?KHF 1960 (R>L, MA>K> :K> =:M: O>G=HKL MA:M L>EE MABL =N;BHNL =:M:) >QI><MBG@ PBMA ?:BMA MA:M BM PBEE I>K?HKF MA> L:F> BG 2008. +K BM PHNE= ;> BG:IIKHIKB:M> MH M>LM : LRLM>F HG : BNG= =:M: L>KB>L PA>G BM P:L LMBEE MK:=>= HG HI>G HNM<KR BG (HG=HG BG MA> 1980L. %M BL :ELH <E>:K MA:M : L>KBHNL MK:=>K LAHNE= <NM :P:R :;GHKF:E <BK<NFLM:G<>L EBD> MA> LMH<D ;N;;E> BG 1999-2000 HK MA> <KN=> HBE LIBD> BG 2008. !O>KR LRLM>F PHKDL PA>G OHE:MBEBMR BL AN@> :G= F:KD>M FHO>F>GML :K> MA> PB=>LM. BNM HGER : KH;NLM :G= <HGLBLM>GM LRLM>F PBEE :EP:RL PHKD BG GHKF:E <HG=BMBHGL. A;GHKF:E <HG=BMBHGL PBEE A:II>G :G= P> DGHP MA:M P> PBEE ?:<> MA>F. BNM F:KD>ML PBEE ;> GHKF:E 80% H? MA> MBF> :G= : @HH= LRLM>F DGHPL PA>G : F:KD>M BL K>:EER HNM H? <HGMKHE :G= KBLDL :K> MHH AB@A.

Rule complexity and degrees of freedom


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

15

Trading Systems

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

16

Design, test, optimisation and evaluation of a trading system

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

/H >O>G BG :G BGMNBMBO> P:R P> :KKBO> :M MA> <HG<ENLBHG MA:M MA> PB=>K MA> L:FIE> LBS> :G= MA> EHP>K MA> GNF;>K H? O:KB:;E>L, MA> ;>MM>K MA> >LMBF:MBHG. .H;>KM ,:K=H BL MA> HGER :NMAHK BG MA> <NKK>GM EBM>K:MNK> MA:M BL :;E> MH D>>I MA> MHIB< F:G:@>:;E> :G= A> @BO>L MA> ?HEEHPBG@ LAHKM-<NM @NB=>EBG>L BG ABL ;HHD 748:
Calc'la&i! !f &he deg$ee% !f f$eed!m = (h!le da&a %am"le * $'le% a d c! di&i! % * da&a c! %'med b) $'le% a d c! di&i! %

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

17

Trading Systems

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
S&a da$d E$$!$ = %#'a$e $!!& !f Whe$e = 'mbe$ !f &he &$ade% + 1

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

18

Design, test, optimisation and evaluation of a trading system

2.3 The forecasting power of a trading system

Optimisation
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

19

Trading Systems

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

20

Design, test, optimisation and evaluation of a trading system

Walk forward analysis


%G <HG<ENLBHG P> <:G LM:M> MA:M HIMBFBL:MBHG BL LHF>MABG@ O:KB:;E> BG M>KFL H? =:M: PBG=HP LBG<> LRLM>FL G>>= MH ;> D>IM BG LRG<AKHGBL:MBHG PBMA MA> F:KD>M. B>?HK> <HFINM>K IHP>K ;><:F> LH <A>:I :G= >:LR MH >FIEHR ?HK MA> F:CHKBMR H? F:KD>M IE:R>KL, :G XHNM-H?-L:FIE> I>KBH=Y P:L :EP:RL K><HFF>G=>= :?M>K HIMBFBL:MBHG ;R :EE MA> MK:=BG@ LRLM>FL[ =>O>EHI>KL. 0A> XHNM-H?-L:FIE> I>KBH=Y BL : =:M: PBG=HP (NLN:EER 10 MH 20% H? MA> PAHE> HIMBFBL:MBHG =:M: PBG=HP) P> D>>I HNMLB=> MA> HIMBFBL:MBHG IKH<>LL :G= PAB<A P> :IIER MH MA> HIMBFBL>= MK:=BG@ LRLM>F BG HK=>K MH O>KB?R BML ?HK><:LMBG@ IHP>K HO>K NGL>>G =:M:. %? MA> LRLM>F I>K?HKFL BG MA> L:F> F:GG>K HO>K MA> NGL>>G =:M: H? MA> XHNMH?-L:FIE> =:M:Y BM F>:GL MA:M MA> LRLM>F BL : KH;NLM HG> :G= BM <:G ;> MK:=>= PBMA <HG?B=>G<>. /H ?:K P> A:O> HGER =BL<NLL>= B=>:L MA:M RHN <:G K>:= BG :GR H? MA> ;HHDL BG <BK<NE:MBHG :;HNM MK:=BG@ LRLM>FL. BNM MABL BL :G H;LHE>M> OB>P H? HIMBFBL:MBHG, F:R;> =:MBG@ ;:<D MH MAHL> MBF>L PA>K> <HFINM>K IHP>K P:L G>BMA>K <A>:I GHK PB=>ER :O:BE:;E>. 0H=:R HIMBFBL:MBHG A:L >OHEO>= BGMH : FHK> >??B<B>GM :G= IKHI>K F>MAH= H? M>LMBG@ :G= F:DBG@ : LRLM>F ?BM HO>K : EHG@ IKB<> L>KB>L. 0ABL F>MAH= @H>L NG=>K MA> G:F> H? XP:ED ?HKP:K= :G:ERLBLY HK XP:ED ?HKP:K= M>LMBG@Y. 3:ED ?HKP:K= M>LMBG@ BL : DBG= H? FNEMBIE> :G= LN<<>LLBO> HNM-H?-L:FIE> M>LM HO>K MA> L:F> =:M: L>KB>L. (>M NL @BO> :G >Q:FIE>: : LRLM>F BL HIMBFBL>= HO>K MA> ?BKLM MPH R>:KL H? MA> =:M: ABLMHKR :G= MA>G :IIEB>= HO>K MA> LN;L>JN>GM 6 FHGMAL H? NGL>>G =:M:. 0A>G MA> HIMBFBL:MBHG PBG=HP FHO>L :A>:= ;R : 6-FHGMA I>KBH= :G= : G>P HIMBFBL:MBHG M:D>L IE:<> BG HK=>K MH ?BG= MA> G>P BGINML MA:M PBEE ;> :IIEB>= HO>K MA> ?HKMA<HFBG@ 6 FHGMAL H? =:M:. AG= LH HG. 0ABL DBG= H? HIMBFBL:MBHG BL : XKHEEBG@Y P:ED ?HKP:K= :G:ERLBL LBG<> MA> LM:KMBG@ I>KBH= H? MA> HIMBFBL:MBHG PBG=HP BL :EP:RL FHOBG@ :A>:= ;R : 6-FHGMA I>KBH= >:<A MBF> P> K>-HIMBFBL> MA> BGINML. %? MA> LM:KMBG@ I>KBH= BL :EP:RL MA> L:F> :G= MA> HIMBFBL:MBHG I>KBH= @>ML EHG@>K :G= EHG@>K :L MA> MBF> @H>L ;R P> A:O> :G X:G<AHK>=Y P:ED ?HKP:K= :G:ERLBL. "HK BGMK:=:R LRLM>FL MA> XKHEEBG@Y P:ED ?HKP:K= :G:ERLBL BL FHK> :IIKHIKB:M> LBG<> BGMK:=:R MK:=BG@ LRLM>FL :K> FHK> LNBM>= MH MA> <A:G@BG@ F:KD>M <HG=BMBHGL.

21

Trading Systems

Figure 2.1: A graphical description of a rolling and anchored walk forward analysis

Rolling walk forward: out-of-sample (OOS) = 20%:

Run #1 |--------- In-sample 80% -------------- | OOS 20% | Run #2 Run #3 |---------- In-sample 80% ------------ | OOS 20% | |---------- In-sample 80% --------------------- | OOS 20% |

Anchored walk forward: out-of-sample (OOS) = 20%:

Run #1 |--------------In-sample 80% --------------- | OOS 20% | Run #2 |----------------------------- In-sample 80% --------------- | OOS 20% | Run #3 |-------------------------------------------- In-sample 80% --------------- | OOS 20% |

0A> >JNBMR EBG> K>LNEMBG@ ?KHF : P:ED ?HKP:K= KNG BL PA>K> P> :K> <EHL>LM MH K>:EBMR BG MK:=BG@ LRLM>FL =>O>EHIF>GM LBG<> BM BL PA:M K>:E MK:=BG@ PBEE IKH=N<> BG HNK IH<D>ML. AG= PBMA GH LNKIKBL> MABL P:ED ?HKP:K= :G:ERLBL >JNBMR EBG> PBEE ;> =>>IER =B??>K>GM ?KHF MA> >JNBMR EBG> P> <:G IKH=N<> PBMA M>LMBG@ :G= HIMBFBLBG@ : MK:=BG@ LRLM>F HG MA> PAHE> IKB<> L>KB>L. /H H?M>G MK:=>KL ?HHE MA>FL>EO>L =><B=BG@ PA>MA>K : MK:=BG@ LRLM>F BL MH ;> =BL<:K=>= HK GHM ;:L>= HG : PAHE> IKB<> L>KB>L >JNBMR EBG> MA:M BG K>:EBMR K>O>:EL GHMABG@ :;HNM MA> K>:E MK:=BG@ LBMN:MBHG :?M>K I>KBH=B< K>-HIMBFBL:MBHG. A PB=>ER :<<>IM>= P:R MH @:N@> MA> ?HK><:LMBG@ IHP>K H? : LRLM>F :G= BML <HGLBLM>G<R BL MH <:E<NE:M> MA> K:MBH ;>MP>>G MA> :GGN:EBL>= G>M IKH?BM K>E:MBG@ MH MA> P:ED ?HKP:K= M>LML :G= MA> :GGN:EBL>= G>M IKH?BM K>:I>= =NKBG@ MA> HIMBFBL:MBHG I>KBH=L. 0ABL BL MA> P:ED ?HKP:K= >??B<B>G<R K:MBH. %? MA> K:MBH BL :;HO> MA> 100% MAK>LAHE= MA>G MA> LRLM>F BL >??B<B>GM :G= MA> IKH;:;BEBMR MA:M BM PBEE D>>I BML ?HK><:LMBG@ IHP>K =NKBG@ K>:E MK:=BG@ BL AB@A. %? : MK:=>K =><B=>L MH MK:=> : LRLM>F PBMA : P:ED ?HKP:K= >??B<B>G<R K:MBH H? CNLM 50% (:G= F:GR MK:=>KL :<<>IM MABL E>O>E :L MA> EHP>LM IHLLB;E>) MA>R LAHNE= >QI><M : LRLM>F MA:M I>K?HKFL :M E>:LM :M A:E? MA> E>O>E H? MA> I>K?HKF:G<>L BG=B<:M>= BGMH MA> HIMBFBL:MBHG M>LM. /M:MBLMB<:E >OB=>G<> :ELH IBGIHBGML MA:M : IHHKER HIMBFBL>= LRLM>F <HNE= F:D> @HH= I>K?HKF:G<>L HG LHF> EN<DR HG> HK MPH P:ED ?HKP:K= M>LML. 0H :OHB= MABL MK:I MA> AB@A>LM IHLLB;E> GNF;>K H? M>LML LAHNE= ;> I>K?HKF>= HK :M E>:LM 10 P:ED ?HKP:K=

22

Design, test, optimisation and evaluation of a trading system

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

Robustness
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

23

Trading Systems

/H MA> GNF;>K H? BGINML, <HG=BMBHGL :G= O:KB:;E>L FNLM ;> D>IM NG=>K <HGMKHE :G= K>=N<>= MH BML FBGBFNF M>KF. BNM AHP F:GR BGINML, <HG=BMBHGL :G= O:KB:;E>L :K> MHH F:GR? 0ABL BL : <HGMKHO>KLB:E :K>: PA>K> MA> NGBJN> A:EEF:KD BL MA> GNF;>K H? =>@K>>L H? ?K>>=HF MA:M FNLM :EP:RL K>LI><M MA> GNF>KB<:E <HG=BMBHG P> =>IB<M>= BG MA> IK>OBHNL I:K:@K:IA. B>?HK> M:DBG@ :G BGINM BGMH <HGLB=>K:MBHG BM BL H;OBHNLER BFIHKM:GM MH <A><D PBMA : K:IB= :G= <NKLHKR HIMBFBL:MBHG B? MA> BGINM O:KB>L HK B? BM =H>L GHM A:O> :GR <A:G@> NG=>K HIMBFBL:MBHG. %? GHM, D>>I BM <HGLM:GM BG HK=>K MH BG<K>:L> MA> =>@K>>L H? ?K>>=HF. AGHMA>K IHBGM MH ;> <HGLB=>K>= BL PA:M L<:G K:G@> MH <AHHL> ?HK >:<A BGINM. AG >Q:FIE> PBEE @BO> : <E>:K>K IB<MNK> H? MABL IKH;E>F: B? RHN P:GM MH M>LM : FHOBG@ :O>K:@> <KHLLHO>K LRLM>F PBMA : LAHKM-M>KF FHOBG@ :O>K:@> :G= : EHG@-M>KF FHOBG@ :O>K:@> HG =:BER =:M:, RHN <:GGHM M>LM MA> LAHKM FHOBG@ :O>K:@> ?KHF 1 MH 20 (MABL BL PA:M BL <HGLB=>K>= MA> LAHKM M>KF PBMA =:BER =:M:) :G= MA> EHG@ FHOBG@ :O>K:@> ?KHF 20 MH 200 (MA> E:MM>K BL MA> BGM>KO:E MA:M BL NLN:EER <HGLB=>K>= EHG@ M>KF PBMA =:BER =:M:). %G=>>= : LM>I ?KHF 1 MH 2 BL : 100% <A:G@> :G= : LM>I ?KHF 19 MH 20 BL : 5% <A:G@>. BNM : LM>I <A:G@> ?KHF 199 MH 200 BL CNLM : 0.5 % <A:G@>. 5HN G>>= MH INM MA> LM>I L<:G K:G@> BG :G :EFHLM I:K:EE>E K>E:MBHGLABI LH MA:M MA> L<:G ?KHF 1 MH 20 PBEE ;> I>K?HKF>= PBMA : LM>I H? 2 :G= MA> L<:G ?KHF 20 MH 200 PBEE ;> I>K?HKF>= PBMA : LM>I H? 20. A?M>K HIMBFBL:MBHG BL =HG> : <KBMB<:E =><BLBHG LAHNE= ;> M:D>G: PAB<A BGINML[ ;:M<A LAHNE= P> <AHHL>? "BKLM H? :EE PA:M P> G>>= MH =H BL <K>:M> : ?NG<MBHG <A:KM MA:M INML MA> O:KB:;E>[L BGINML L<:G K:G@> BG K>E:MBHG MH MA> G>M IKH?BML (HK PAB<A>O>K >EL> <KBM>KB: P:L <AHL>G ?HK HIMBFBL:MBHG).

24

Design, test, optimisation and evaluation of a trading system

Figure 2.2: In the middle of the chart as the variable varies the net profit stays almost at the same level.

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

25

Trading Systems

Figure 2.3: As much as the variable changes the net profit shows deep and wide swings: there is no area where at the variables changing net profit stays more or less stable.

%G LNFF:KR P> <:G LM:M> MA:M MA>K> LAHNE= ;> : EH@B<:E I:MA BGMH MA> BGINML[ K>LNEML LH MA:M LHF>MABG@ <HA>K>GM BG M>KFL H? BGINML[ ;:M<A LAHNE= :KBL>. 3A>G MA>K> BL GHM : EBG>:K K>E:MBHGLABI PBMA BGINML :G= G>M IKH?BML, HK =K:P=HPG, HK PAB<A>O>K <HGLMK:BGM RHN :K> INMMBG@ :L : IKBF:KR KNE> H? MA> HIMBFBL:MBHG, MA> PAHE> L>M H? K>LNEML FNLM ;> K>@:K=>= :L LNLIB<BHNL.

26

Design, test, optimisation and evaluation of a trading system

2.4 Evaluation of a trading system


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

What to look for in an indicator


Ne- )+(f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

27

Trading Systems

;> :;E> MH ?HEEHP MABL LRLM>F BG MA> ?NMNK>? *H;H=R PBEE MK:=> LN<A : LRLM>F ;><:NL> BM BL :II:K>GM MA:M MA> PBG=?:EE 10 R>:KL :@H <HNE= EBD>ER ;> :G HNMEB>K, :G :;GHKF:E H<<NKK>G<> MA:M PBEE G>O>K ;> K>I>:M>=. /H P> <:G <HG<EN=> MA:M : <HGLBLM>GM MK:=BG@ LRLM>F A:L :G >O>G =BLMKB;NMBHG GHM HGER H? IKH?BML :G= EHLL>L ;NM :ELH H? MA> L>KB>L H? <HGL><NMBO> PBGGBG@ :G= EHLBG@ MK:=>L. %? RHN <NM MA> LM:MBLMB<L H? : <HGLBLM>GM MK:=BG@ LRLM>F R>:K ;R R>:K RHN PBEE ?BG= :EE MA> BG=B<:MHKL PBEE ;> :EFHLM MA> L:F>. %? LN;LM:GMB:E =B??>K>G<>L :KBL> ?KHF R>:K MH R>:K HK ?KHF FHGMA MH FHGMA MA> MK:=BG@ LRLM>F BL GHM <HGLBLM>GM. AG BGMK:=:R LRLM>F <HNE= :ELH ;> @:N@>= ;R P>>DER I>K?HKF:G<>L.

Average trade
AG BFIHKM:GM BG=B<:MHK H? MA> @HH=G>LL H? : MK:=BG@ LRLM>F BL MA> a/e+a e -+ade, MA:M BL MA> G>M IKH?BM =BOB=>= ;R MA> GNF;>K H? MK:=>L. AO>K:@> MK:=> M>EEL NL AHP FN<A FHG>R P> F:D> HK EHL> I>K MK:=>. %G :;LHENM> M>KFL MA> :O>K:@> MK:=> LAHNE= ;> <:I:;E> H? <HO>KBG@ LEBII:@> :G= <HFFBLLBHGL :G= MA>G LMBEE E>:O> LHF> IKH?BM ?HK MA> MK:=>K. %G I>K<>GM:@> M>KFL MA> :O>K:@> MK:=> LAHNE= ;> <HGLBLM>GM MAKHN@AHNM MA> PAHE> M>LMBG@ I>KBH=. 1LN:EER MK:=>KL <HFI:K> MA> :;LHENM> :O>K:@> MK:=> PBMA MA> >GMKR IKB<> H? MA:M I:KMB<NE:K MK:=> LH MA:M BM BL >QIK>LL>= BG I>K<>GM:@> M>KFL. +MA>K MK:=>KL <HFI:K> MA> GHFBG:E :O>K:@> MK:=> O:EN> PBMA MA> GHFBG:E O:EN> H? MA> <HGMK:<M BG : @BO>G I>KBH=. 3A:M P> <:G K><HFF>G= BL MH IEHM MA> ABLMHKB<:E :O>K:@> I>K<>GM:@> O:EN> H? MA> MK:=>L BG HK=>K MH A:O> : <E>:K IB<MNK> H? MA> IKH?BM:;BEBMR MK>G= H? MA> LRLM>F HO>K MA> R>:KL.

Percentage of profitable trades


0A> )e+ce'- )+(f"-ab%e -+ade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

28

Design, test, optimisation and evaluation of a trading system

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

29

Trading Systems

LRLM>FL BG LI><B:E LBMN:MBHGL, MK:=> =>I>G=>G<B>L <:G H<<NK 758. BNM MABL BL : LHIABLMB<:M>= MHIB< MA:M @H>L ;>RHG= H? MA> L<HI> H? MABL ;HHD. %G :GR <:L> P> K><HFF>G= K>:=>KL :IIKH:<A MABL MHIB< PBMA >QMK>F> IKN=>G<>.

Profit factor
P+(f"- fac-(+ BL : I>K?><M BG=B<:MHK ?HK <HFI:KBG@ =B??>K>GM LRLM>FL HK MA> L:F> LRLM>F IEHMM>= HO>K =B??>K>GM F:KD>ML. +? <HNKL> MABL BG=B<:MHK BL : K:MBH LH BM =H>L GHM LN??>K ?KHF MA> NLN:E =K:P;:<D H? MA> HMA>K :;LHENM> GNF;>K K:MBHL. ,KH?BM ?:<MHK BL @KHLL IKH?BM =BOB=>= ;R @KHLL EHLL :G= ;:LB<:EER K>O>:EL MA> LBS> H? @KHLL IKH?BM BG K>E:MBHG MH @KHLL EHLL. 0A> AB@A>K MA> ;>MM>K. 1LN:EER : A>:EMAR MK:=BG@ LRLM>F A:L : IKH?BM ?:<MHK H? 2, :G :O>K:@> PBGGBG@ MK:=>/:O>K:@> EHLBG@ MK:=> K:MBH H? 2 :G= : I>K<>GM:@> H? IKH?BM:;E> MK:=>L GNF;>K >JN:E MH 50%. BNM MA>K> :K> :ELH @HH= LRLM>FL PBMA : IKH?BM ?:<MHK H? ;>MP>>G 1.5 :G= 3. 0ABGD :@:BG :;HNM PA:M RHN =B= =NKBG@ HIMFBL:MBHG :G= RHNK LRLM>F[L =>LB@G :G= =>O>EHIF>GM PA>G RHNK IKH?BM ?:<MHK @H>L HO>K 3.

Drawdown
A ;KH:= =>?BGBMBHG H? d+a0d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e'd -+ade d+a0d(0' M>EEL NL AHP FN<A H? MA> HI>G IKH?BM P> A:= MH @BO> ;:<D ;>?HK> P> P>K> :EEHP>= MH >QBM : LI><B?B< MK:=> A c%(,e -+ade d+a0d(0' BL MA> =B??>K>G<> ;>MP>>G MA> >GMKR :G= MA> >QBM IKB<> PBMAHNM M:DBG@ BGMH <HGLB=>K:MBHG PA:M BL @HBG@ HG PBMABG MA> MK:=> A ,-a+- -+ade d+a0d(0' F>:LNK>L AHP FN<A MA> MK:=> P>GM :@:BGLM NL :?M>K MA> >GMKR :G= ;>?HK> BM LM:KM>= MH @H HNK P:R 768.

"HK L:D> H? LBFIEB<BMR P> PBEE NL> MA> <EHL> MK:=> =K:P=HPG =>?BGBMBHG LBG<> BM BL MA> FHLM LB@GB?B<:GM. BNM BM BL BFIHKM:GM MH K>F>F;>K MA:M PABE> MK:=BG@ K>:E FHG>R P> <:G >G=NK> :G HI>G MK:=> =K:P=HPG FN<A ;B@@>K MA:G MA> MA>HK>MB<:EER <:E<NE:M>= <EHL>= MK:=> =K:P=HPG.

30

Design, test, optimisation and evaluation of a trading system

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

Time averages
+MA>K BFIHKM:GM BG=B<:MHKL BG<EN=> MA> -"&e a/e+a e,. AO>K:@> MBF> BG MK:=>L, :<<HK=BG@ MH MA> 0K:=>/M:MBHG M>KFBGHEH@R, =BLIE:RL MA> :O>K:@> MBF> (R>:KL, =:RL, FBGNM>L) LI>GM BG :EE <HFIE>M>= MK:=>L, =NKBG@ MA> LI><B?B>= I>KBH= ?HK MA> LMK:M>@R. +MA>K MK:=BG@ IE:M?HKFL A:O> LBFBE:K BG=B<:MHKL. AO>K:@> MBF> BG MK:=>L BL OBM:E ?HK IHKM?HEBH <HGLMKN<MBHG LBG<> MH >QIEHBM G>@:MBO> <HKK>E:MBHG :FHG@ >JNBMR EBG>L RHNK LRLM>FL G>>= MH ;> BG MA>

31

Trading Systems

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

RINA Index
A IHP>K?NE BG=B<:MHK <K>:M>= ;R .%*A /RLM>FL :G= BG<EN=>= BG MA> 0K:=>/M:MBHG MK:=BG@ LRLM>F K>IHKM BL MA> RINA I'de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e*."-2 %"'e, PAB<A G>>=L MH ;> @KHPBG@ LFHHMAER :G= PBMAHNM F:GR =>>I =K:P=HPGL. ,>KLHG:EER P> :ELH :IIK><B:M> F:GR X?E:M MBF>LY, MA:M BL I:KML H? MA> >JNBMR EBG> MA:M :K> AHKBSHGM:E: BM F>:GL MA:M GH MK:=BG@ P:L =HG> BG MA:M I>KBH= LBG<> : ?BEM>K MHHD MA> LRLM>F HNM H? MA> F:KD>M. 3> ;>EB>O> MA:M MA>K> BL GH G>>= MH MK:=> <HGMBGNHNLER :G= : @HH= LRLM>F LAHNE= DGHP PA>G MA>K> BL LHF> >=@> MH ;> >QIEHBM>= HO>K MA> F:KD>ML :G= <HGO>KL>ER PA>G BM

32

Design, test, optimisation and evaluation of a trading system

BL FHK> :IIKHIKB:M> MH LBM HG MA> LB=>EBG>L. 0A>G, :?M>K MA> >JNBMR EBG>, P> BFF>=B:M>ER <A><D :O>K:@> MK:=>, IKH?BM ?:<MHK, I>K<>GM IKH?BM:;E>, :O>K:@> PBG/:O>K:@> EHLL :G= AHP MA> FHGMAER K>MNKGL P>K> =BLMKB;NM>= MAKHN@AHNM MA> R>:KL. &NLM ?KHF MA>L> BG=B<:MHKL : IKHI>K CN=@F>GM :;HNM MA> MK:=BG@ LRLM>F <:G ;> =K:PG PBMAHNM FN<A PHKKR :;HNM ;>BG@ HG MA> PKHG@ LB=>.

2.5 Conclusion
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

33

Part II:
Trading System Development and Evaluation of a Real Case

3
How to develop a trading system step-bystep using the example of the British pound/US dollar pair
Introduction
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

37

Trading Systems

3.2 !O:EN:MBHG H? MA> MK:=BG@ LRLM>F PBMAHNM I:K:F>M>K HIMBFBL:MBHG :G= >QBML W MA> BFIHKM:G<> H? <HFFBLLBHGL :G= LEBII:@>. 3.3 2:KB:MBHG H? MA> BGINM I:K:F>M>KL: +IMBFBL:MBHG :G= LM:;BEBMR @K:IAL. 3.4 %GL>KMBG@ :G BGMK:=:R MBF> ?BEM>K: MA> BFIHKM:G<> H? MBF> ?HK LAHKM-M>KF MK:=BG@. 3.5 >M>KFBG:MBHG H? :IIKHIKB:M> >QBML ?HK RHNK LRLM>F ;R <A><DBG@ MA> =>O>EHIF>GM H? :EE MA> LRLM>F[L MK:=>L. $HP &HAG /P>>G>R[L ):QBFNF A=O>KL> :G= ):QBFNF ":OHNK:;E> !Q<NKLBHG <:G LNIIHKM RHN.

(>M[L LM:KM PBMA MA> =>L<KBIMBHG H? MA> EH@B< H? MA> LRLM>F.

3.1 The birth of a trading system


AL F>GMBHG>= BG MA> BGMKH=N<MBHG MA>K> :K> EHML H? LHNK<>L ?HK =>O>EHIBG@ RHNK HPG IHHE H? MK:=BG@ LRLM>FL. +G> H? MA>F BL <>KM:BGER MA> /MK:M>@R 0K:=BG@ :G= >O>EHIF>GM CEN; (BG LAHKM X/0A Y) H? +F>@: .>L>:K<A (0K:=>/M:MBHG). AL : LM:KMBG@ IHBGM P> M:D> MA> ?HEEHPBG@ >GMKR EH@B<, :L >QIE:BG>= BG /0A , OHENF> 13:
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

38

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

The free LUXOR system code


0A> IKH@K:FF>KL PAH P:GM MH BFIE>F>GM MABL EH@B< <:G ?BG= MA> <H=> H? MA> MK:=BG@ LRLM>F BG 0K:=>/M:MBHG[L !:LR (:G@N:@> ;>EHP. (+MA>K K>:=>KL <:G LDBI MABL I:K:@K:IA :G= <HGMBGN> HG MH MA> =>L<KBIMBHG H? MA> MK:=BG@ LRLM>F.) 3> :==>= LHF> <HFF>GML BGMH MA> <H=> LH MA:M RHN DGHP PA:M BL =HG> :G= LH MA:M RHN <:G <A:G@> MA> <H=> >:LBER :<<HK=BG@ MH RHNK G>>=L.
Text 3.1: Easy Language Code of the LUXOR trading system. Bold letters: Code for the entries. Normal letters: added time filter. In comment brackets: possible simple exits.

{Copyright 2000. OMEGA RESEARCH, INC. MIAMI, FLORIDA. Strategy Trading and Development Club STAD, Volume 13, Modified 18 June 2006 and 15 July 2008 by Urban Jaekle Modified 1 January 2007 by Russell Stagg} {1. Definition of necessary inputs and variables} Inputs: FastLength( 3 ), {The input parameters of the two moving averages }

SlowLength( 30 ), tset(1600), WindowDist(100); {start time for the intraday time window filter} {window distance for the intraday time window filter} {can be changed this makes optimisation possible} Variables: {Definition of needed variables}

MP(0), Fast(0), Slow(0), GoLong(False), GoShort(False), BuyStop(0), SellStop(0), BuyLimit(0), SellLimit(0), tEnd(1700); MP = MarketPosition; {2. Time window filter; see below: 3.4, Inserting an intraday time filter} tend=tset+WindowDist; {time window of 1 hour} if time > tset - 5 and time < tend then begin

39

Trading Systems

{3. Definition of moving averages and entry conditions} Fast = Average(Close, FastLength); Slow = Average(Close, SlowLength); GoLong = Fast > Slow; GoShort = Fast < Slow; {4. Entry Setup} If Fast crosses above Slow then begin BuyStop = High + 1 point; BuyLimit = High + 5 points; end; If Fast crosses below Slow then begin SellStop = Low - 1 point; SellLimit= Low - 5 points; end; If GoLong and C < BuyLimit then Buy (Long) next bar at BuyStop Stop; If GoShort and C > SellLimit then Sell Short (Short) next bar at SellStop Stop; {5. Exits: Derived from the slow moving average. These exits are not used here since we take different standard exits! Feel free to change the exits according to your needs} {If MP = 1 then Begin Sell next bar at Slow - 1 point Stop; End; If MP = -1 then Begin Buy to Cover next bar at Slow + 1 point Stop; End;} end;

40

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

0A> !:LR (:G@N:@> CH=> <:G ;> =BOB=>= BGMH =B??>K>GM I:KML: 1. 2. 3. >?BGBMBHG H? BGINML :G= O:KB:;E>L 0BF> ?BEM>K (=BL<NLL>= ;>EHP BG 3.4) !GMKR :G= >QBM L>MNI

/BG<> MABL ?BKLM L><MBHG H? MABL <A:IM>K ?H<NL>L HG MA> >GMKR EH@B< P> A:O> INM MA> >QBM I:KM H? MA> MK:=BG@ LRLM>F BG MA> !:LR (:G@N:@> CH=> BG ;K:<D>ML. 0ABL F>:GL MA:M ?BKLM P> E>:O> MA> >QBML HNM :G= HGER M:D> MA> >GMKB>L ?KHF MABL LRLM>F. (:M>K BG MABL <A:IM>K P> NL> MA>L> >GMKB>L :G= :IIER HNK HPG >QBML MH MA>F.

The entry logic


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

41

Trading Systems

Figure 3.1: Entry Logic. The entry is not triggered by the crossing of the two moving averages. Instead, at the crossover bar the high is kept and used as a long entry level. Short entries are taken symmetrically. Chart example was taken from British pound/US dollar, 30 min, FOREX from 26 Dec 2007. Chart and datafeed from TradeStation 8.

0A> LRLM>F A:L MA> ?HEEHPBG@ MPH BGINM I:K:F>M>KL PAB<A <:G ;> O:KB>= :G= HIMBFBL>=:
Inputs: FastLength (3), SlowLength (30);

0A>L> MPH BGINM I:K:F>M>KL X":LM(>G@MAY :G= X/EHP(>G@MAY :K> NL>= ?HK MA> ?:LM :G= LEHP FHOBG@ :O>K:@>:
Fast = Moving Average (Close, FastLength); Slow = Moving Average (Close, SlowLength);

*HP MA> BFIHKM:GM ;K>:DHNM ?BEM>K BL :==>=. AM MA> ;:K PA>G MA> ?:LM FHOBG@ :O>K:@> <KHLL>L :;HO> MA> LEHP FHOBG@ :O>K:@> MA> MK:=> BL GHM =BK><MER BGBMB:M>=. 3> M:D> MA> AB@A H? MABL ;:K (X<KHLLHO>K ;:KY, F:KD>= BG K>= <HEHNK BG "B@NK> 3.1) :G= D>>I BM :L MA> >GMKR LMHI IHBGM :L EHG@ :L MA> ?:LM FHOBG@ :O>K:@> LM:RL :;HO> MA> LEHP FHOBG@ :O>K:@>:
If Fast crosses above Slow Then EntryLevel = High; If Fast > Slow then Buy (Long) next bar at BuyStop Stop;

42

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

0ABL LBFIE> ;NM >??><MBO> <HG=BMBHG BFIKHO>L MA> IKH;:;BEBMR H? MA> LBFIE> MK>G= ?HEEHPBG@ LRLM>F <:IMNKBG@ MA> FHLM IKH?BM:;E> ;K>:DHNML :G= GHM CNLM :GR FHOBG@ :O>K:@> <KHLLHO>K PAB<A H<<NKL. %M BL =B??>K>GM MH <HFFHG FHOBG@ :O>K:@> <KHLLHO>K LRLM>FL PA>K> >O>KR MK:=> BL M:D>G, LBG<> MA> :==BMBHG:E ?BEM>K A:L MH <HG?BKF MA> FHOBG@ :O>K:@>L :G= BG MABL P:R IK>O>GML MK:=BG@ LHF> ?:EL> ;K>:DHNML.

3.2 First evaluation of the trading system

Calculation without slippage and commissions


0A> LMK:M>@R BL GHP :IIEB>= MH 30 FBGNM> "+.!4 =:M: ?KHF 21/10/2002 MH 4/7/2008. AEE MA> ?HEEHPBG@ <:E<NE:MBHGL BG MABL <A:IM>K :K> ;:L>= HG : HG> <HGMK:<M ;:LBL. '>>IBG@ MA> ;>@BGGBG@ LBFIE> P> <:E<NE:M> MA> MK:=BG@ LRLM>F[L K>LNEML PBMAHNM :GR LEBII:@> :G= <HFFBLLBHGL. 0A>L> PBEE ;> :==>= BG MA> G>QM L><MBHG PA>K> P> PBEE >Q:FBG> MA>BK BFI:<M HG LRLM>F I>K?HKF:G<>. "NKMA>KFHK> IE>:L> GHM> MA:M :M ?BKLM P> <A><D MA> LRLM>F CNLM PBMA >GMKB>L :G= MK:=> K>O>KL:EL, E>:OBG@ HNM >QBML. AL ?BKLM BGINM I:K:F>M>KL ?HK MA> MK:=BG@ LRLM>F[L >GMKB>L P> <AHHL> 10 ;:KL ?HK MA> ?:LM :G= 30 ;:KL ?HK MA> LEHP FHOBG@ :O>K:@>. 3BMA 30 FBGNM> ;:KL MABL F>:GL MA> ?:LM FHOBG@ :O>K:@> BL <:E<NE:M>= ?KHF MA> E:LM 5 MK:=BG@ AHNKL PA>K>:L MA> LEHP FHOBG@ :O>K:@> K>EB>L HG MA> E:LM 15 AHNKL. "B@NK> 3.2 LAHPL MA> K>LNEMBG@ >JNBMR <NKO> BG : =>M:BE>= ?HKF. 3BMA X=>M:BE>= ?HKFY P> F>:G MA:M MABL <NKO> LAHPL :EE KNG-NIL :G= =K:P=HPGL H? MA> MK:=>L PAB<A A:II>G =NKBG@ MA>BK EB?>MBF>. (BD> MABL MA> >JNBMR EBG> BL FHK> BG?HKF:MBO> <HFI:K>= MH : ?HKF PA>K> CNLM >G=-H?-=:R HK >O>G >G=-H?-FHGMA K>LNEML :K> LAHPG.

43

Trading Systems

Figure 3.2: Detailed Equity Curve of the trading system LUXOR on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Input parameters: SLOW=30, FAST=10. System without exits, always in the market. Back-test without any slippage and commissions. Chart from TradeStation 8.

Equity curve detailed GBPUSD 30 min(21/10/02 02:30 04/07/08 12:30)

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

44

Equity ($)

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

Table 3.1: Main system figures of the LUXOR system. British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Input parameters: SLOW=30, FAST=10. System without exits, always in the market. Back-test calculation without any slippage and commission.

All Trades
Total Net Profit Gross Profit Gross Loss Profit Factor Total Number of Trades Percent Profitable Winning Trades Losing Trades Avg. Trade Net Profit Avg. Winning Trade Avg. Losing Trade Ratio Avg. Win:Avg. Loss Largest Winning Trade Largest Losing Trade Max. Consecutive Winning Trades Max. Consecutive Losing Trades Avg. Bars in Total Trades Avg. Bars in Winning Trades Avg. Bars in Losing Trades Max. Drawdown (Intra-day Peak to Valley) Date of Max. Drawdown $66,318 $590,530 ($524,213) 1.13 1913 36.49% 698 1215 $35 $846 ($431) 1.96 $5,628 ($2,522) 6 16 37.77 61.84 23.94 ($15,644) 27-Nov-03

Long Trades
$56,918 $310,301 ($253,383) 1.22 957 39.81% 381 576 $59 $814 ($440) 1.85 $5,628 ($1,652) 6 10 39.18 62.96 23.45 ($11,133)

Short Trades
$9,400 $280,230 ($270,830) 1.03 956 33.16% 317 639 $10 $884 ($424) 2.09 $4,338 ($2,522) 6 11 36.36 60.5 24.38 ($19,746)

0A> <HGLB=>K>= LRLM>F LAHPL MA> F:BG IKHI>KMB>L H? MK>G= ?HEEHPBG@ MK:=BG@ LMK:M>@B>L: U 0A> I>K<>GM:@> H? IKH?BM:;E> MK:=>L BL EHP (36.5%). "KHF MA> 1913 I>K?HKF>= MK:=>L, HGER 698 :K> IKH?BM:;E> PA>K>:L MA> F:CHKBMR (1215) >G= PBMA : EHLL.

45

Trading Systems

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

46

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

0A>K>?HK> P> :K> GHP :M : IHBGM PA>G MA> MK:=BG@ LRLM>F =>O>EHIF>GM PHKD A:L CNLM LM:KM>=. 0A>K> :K> EHML H? LM>IL MH I>K?HKF NGMBE RHN <:G PHKD HNM : <HFIE>M> MK:=BG@ LRLM>F. 0A> IKH?BM:;BEBMR H? MABL LRLM>F FNLM ;> BG<K>:L>= :G= >QBML FNLM ;> :==>=. B>?HK> P> =H MABL P> M:D> MK:=BG@ <HLML BGMH <HGLB=>K:MBHG MH F:D> MA> PAHE> :IIKH:<A FHK> K>:EBLMB<.

Calculation after adding slippage and commissions


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

47

Trading Systems

Figure 3.3: Result of the trading system LUXOR with added $30 slippage and commission per round turn. A: Detailed equity curve; B: Underwater equity curve. British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Input parameters: SLOW=30, FAST=10. System without exits, always in the market. Chart from TradeStation 8.

0A> LBMN:MBHG ?HK MA> (14+.-MK:=BG@ LRLM>F L>>FL MH ;> AHI>E>LL. 3BMA MABL LRLM>F RHN :K> ?:K :P:R ?KHF @:BGBG@ :GR IKH?BML HG MA> IHNG=/=HEE:K "+.!4 I:BK. '>>I BG FBG= AHP>O>K MA:M P> A:O> CNLM <AHL>G MPH :K;BMK:KR BGINM I:K:F>M>KL. 0A>R <HNE= ;> LNBM:;E> HK GHM. 0A> D>R JN>LMBHG PAB<A A:L MH ;> :GLP>K>= GHP BL: BL MABL MK:=BG@ LRLM>F NL>E>LL
48

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

HO>K:EE, HK BL BM : MK:=BG@ LRLM>F MA:M A:L BML LMK>G@MAL ;NM BL LN??>KBG@ ?KHF MA> BG:IIKHIKB:M> <AHB<> H? BGINM I:K:F>M>KL? 0H :GLP>K MABL JN>LMBHG FHK> LRLM>F M>LML EBD> MA> HG> LAHPG :;HO> PBEE ;> G><>LL:KR ?HK FNEMBIE> =B??>K>GM BGINM I:K:F>M>KL. %G HK=>K MH IK>I:K> MA>L> M>LML P> ?BKLM P:GM MH >QIE:BG PA:M P> :K> EHHDBG@ ?HK PA>G P> I>K?HKF LN<A HIMBFBL:MBHGL LBG<> MA>K> :K> LHF> IBM?:EEL MH :OHB=.

3.3 Variation of the input parameters: optimisation and stability diagrams

What does stability of a systems input parameter mean? A short theoretical excursion
+IMBFBL:MBHG <:G ;> RHNK ;>LM ?KB>G= ;NM :ELH RHNK PHKLM >G>FR PA>G RHN =>O>EHI : MK:=BG@ LRLM>F. 0A> BFIHKM:GM IHBGM BL MA:M RHN :EP:RL DGHP PA:M RHN :K> =HBG@ PA>G RHN O:KR LHF> H? MA> LRLM>F[L BGINM I:K:F>M>KL. '>>I BG FBG= MA:M >O>KR MK:=BG@ LRLM>F BL BG LHF> ?HKF :G HIMBFBL:MBHG. 3A>G RHN L>E><M : LRLM>F RHN <HFI:K> BM PBMA HMA>KL :G= <AHHL> BM ;><:NL> BM A:L LAHPG : LI><B:E ;>A:OBHNK BG MA> I:LM PAB<A <HGOBG<>L RHN MA:M MABL LI><B:E ;>A:OBHNK PBEE AHE= BG MA> ?NMNK>. !O>G B? RHN =H GHM :=CNLM :GR H? BML BGINM I:K:F>M>KL, BG K>C><MBG@ HMA>K, F:R;> LBFBE:K, MK:=BG@ LRLM>FL RHN A:O> >LL>GMB:EER =HG> MABL ;R HIMBFBLBG@ MA> BGINM I:K:F>M>KL X:?M>KP:K=LY PBMA RHNK <HFINM>K. 0A> HI>G JN>LMBHG K>F:BGL: :M PAB<A IHBGM =H>L MA> =>O>EHIF>GM :G= L>E><MBHG IA:L> H? : LRLM>F >G= :G= MA> HIMBFBL:MBHG H? RHNK LRLM>F LM:KM? /BG<> BM <:G G>O>K ;> <HFIE>M>ER L>I:K:M>=, BM BL ;>MM>K MH :<<>IM MA:M >O>KR MK:=BG@ LRLM>F BL BG LHF> P:R :G :=:IM:MBHG H? MA> I:LM :G= MA>K>?HK> BL HIMBFBL>=. /H MA> D>R JN>LMBHG ?HK RHN :L : LRLM>F =>O>EHI>K BL :EP:RL: PAB<A I:K:F>M>K =H RHN <AHHL> ?KHF RHNK ;:<D-M>LML? 3AB<A L>MMBG@L :K> EBD>ER MH <HGMBGN> MH IKH=N<> IKH?BML BG MA> ?NMNK> BG K>:E MK:=BG@? 0A> :GLP>K MH MABL JN>LMBHG BL =B??>K>GM ?HK >:<A MK:=BG@ LRLM>F ;NM HG> KNE> AHE=L MKN> ?HK :EE: MA> G>B@A;HNKAHH= H? RHNK <AHL>G LRLM>F I:K:F>M>KL FNLM ;> G>:KER :L IKH?BM:;E> :L RHNK <AHL>G LRLM>F I:K:F>M>K :G= MA> ;B@@>K MABL IKH?BM:;E> I:K:F>M>K K:G@> BL MA> ;>MM>K. )NKK:R .N@@B>KH, :G >QI>KB>G<>= IKH?>LLBHG:E MK:=BG@ LRLM>FL =>O>EHI>K, PKBM>L :;HNM MABL MHIB< 778: 3If 2(. d('4- %"$e -!e 'e" !b(.+"' '.&be+,, 2(.4/e (- a )+(b%e&, beca.,e (dd, a+e, 2(. 0"%% 0"'d .) 0"-! -!e +e,.%-, (f -!e 'e" !b(.+"' ,e- (f )a+a&e-e+,.4

49

Trading Systems

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
Figure 3.4: Choosing stable parameters for your trading system: Net profit as a function of one system input parameter in arbitrary units. Artificially generated result of a hypothetical trading system.

50

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

Dependency of main system figures on the two moving averages


"KHF MA>HKR ;:<D MH K>:EBMR. (>M[L <A><D AHP HNK MK:=BG@ LRLM>F (14+. ;>A:O>L PA>G <A:G@BG@ BML MPH BGINM I:K:F>M>KL, BG<EN=BG@ MK:=BG@ <HLML H? $30 LEBII:@> :G= <HFFBLLBHGL I>K KHNG= MNKG. 3> P:GM MH L>> AHP MA> K>LNEML H? HNK MK>G=-?HEEHPBG@ LRLM>F <A:G@> PA>G MA> E>G@MAL H? MA> ?:LM :G= LEHP FHOBG@ :O>K:@>L :K> O:KB>=. 3> <A:G@> MA> MPH :O>K:@>L BG : PB=> K:G@>, MA> ?:LM FHOBG@ :O>K:@> E>G@MA ?KHF 1 ;:K MH 20 ;:KL BG LM>IL H? 1, MA> LEHP FHOBG@ :O>K:@> E>G@MA ?KHF 21 ;:KL MH 80 ;:KL, :ELH BG LM>IL H? 1. A ?:LM ,C <HFINM>L MA> G><>LL:KR 1200 LRLM>F M>LML BG :;HNM MAK>> FBGNM>L. "KHF MA>L> M>LML RHN <:G IEHM MA> MHM:E G>M IKH?BM :L : ?NG<MBHG H? MA> MPH O:KB>= BGINM I:K:F>M>KL. 5HN <:G =H MABL ?HK >:<A BGINM I:K:F>M>K L>I:K:M>ER (:L LAHPG BG "B@NK> 3.4) ;NM RHN <:G >O>G =H MABL ?HK MPH LRLM>F I:K:F>M>KL BG MA> L:F> MAK>>-=BF>GLBHG:E :K>: @K:IA ("B@NK> 3.5). (BD> MABL RHN @>M : LNK?:<> BG MAK>> =BF>GLBHGL PAB<A LAHP RHN AHP MA> BGINM I:K:F>M>KL :??><M MA> K>LNEM H? RHNK LRLM>F. 3BMA LI><B:E LH?MP:K> RHN <:G >O>G MNKG MABL @K:IA BG >O>KR =BK><MBHG :G= EHHD :M BM ?KHF =B??>K>GM LB=>L. "B@NK>L 3.5A :G= 3.5B :K> LAHPBG@ MA> L:F> ?:<ML ?KHF =B??>K>GM OB>PL. "B@NK> 3.5A BL LAHPBG@ MA> MHM:E G>M IKH?BM :L : ?NG<MBHG H? MA> MPH FHOBG@ :O>K:@> E>G@MAL ?KHF MA> LB=>, :G= "B@NK> 3.5B LAHPL MA> L:F> HIMBFBL:MBHG K>LNEM ?KHF :;HO>. "KHF MA>L> MPH ?B@NK>L RHN L>> MA:M MA> MK:=BG@ LRLM>F A:L ;>>G IKH?BM:;E> BG : PB=> K:G@> H? BGINM I:K:F>M>K L>MMBG@L (=:KD ;EN> :K>:L) ;NM A:L :ELH IKH=N<>= EHLL>L HK HGER LF:EE IKH?BML BG HMA>K K:G@>L H? I:K:F>M>K L>MMBG@L (R>EEHP, @K>>G :G= EB@AM ;EN> :K>:L).

51

Trading Systems

Figure 3.5: Three-dimensional area diagrams for all trades of the system LUXOR. a) side view, b) top view. Net profit in US dollars as a function of the two input parameters: fast and slow moving average. Tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/20024/7/2008, incl. $30 S+C per RT. Diagrams generated with RINA 3D Smart View.

52

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

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

53

Trading Systems

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
Figure 3.6: Three-dimensional area diagrams for all trades of the trading system LUXOR. Main system figures as a function of the two input parameters: fast and slow moving average. Tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, including $30 S+C per RT. A: net profit B: maximum intraday drawdown C: average trade net profit D: number of total trades generated. Diagrams generated with RINA 3D Smart View.

54

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

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Trading Systems

Result with optimised input values


3BMA MA> ?:LM FHOBG@ :O>K:@> L>M MH 1 ;:K (=<EHLBG@ IKB<> BML>E?) :G= MA> LEHP FHOBG@ :O>K:@> L>M MH 44 ;:KL RHN @>M : LM>:=BER @KHPBG@ >JNBMR <NKO> ("B@NK> 3.7A). 0ABL K>LNEM BL <HG?BKF>= PBMA MA> NG=>KP:M>K->JNBMR <NKO> PAB<A :EP:RL JNB<DER K><HO>KL :?M>K >O>KR =K:P=HPG ("B@NK> 3.7B). 0A> ;B@@>LM =K:P=HPG A:II>G>= BG *HO>F;>K 2003. %M P:L, PBMA 8%, HGER A:E? :L ;B@ :L MA> =K:P=HPG H? FHK> MA:G 15% PAB<A P> @HM PBMA MA> GHGHIMBFBL>= BGINM I:K:F>M>KL (10/30).

56

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

Figure 3.7: Trading system LUXOR, tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Optimised input parameters in terms of net profit: SLOW=44, FAST=1. System without exits, always in the market, long or short. Back-test includes $30 slippage and commission. Chart from TradeStation 8. A: Detailed equity curve; B: Weekly underwater equity curve.

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Trading Systems

Table 3.2: Main system figures of the trading system LUXOR. British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Input parameters: SLOW=44, FAST=1. System without exits, always in the market. Back-test includes $30 slippage and commission per round turn.

All Trades
Total Net Profit Gross Profit Gross Loss Profit Factor Total Number of Trades Percent Profitable Winning Trades Losing Trades Avg. Trade Net Profit Avg. Winning Trade Avg. Losing Trade Ratio Avg. Win:Avg. Loss Largest Winning Trade Largest Losing Trade Max. Consecutive Winning Trades Max. Consecutive Losing Trades Avg. Bars in Total Trades Avg. Bars in Winning Trades Avg. Bars in Losing Trades Max. Drawdown (Intra-day Peak to Valley) Date of Max. Drawdown $100,125 $666,862 ($566,738) 1.18 2980 26.41% 787 2193 $33.60 $847 ($258) 3.28 $5,428 ($2,062) 7 24 24.69 60.75 11.75 ($13,440) 26-Nov-03

Long Trades
$73,888 $347,323 ($273,435) 1.27 1490 28.26% 421 1069 $49.59 $825 ($256) 3.23 $5,428 ($2,062) 7 18 25.61 60.82 11.75 ($7,594)

Short Trades
$26,237 $319,540 ($293,303) 1.09 1490 24.56% 366 1124 $17.61 $873 ($261) 3.35 $4,418 ($1,452) 7 21 23.77 60.66 11.76 ($19,284)

AEMAHN@A MA> HO>K:EE K>MNKG/=K:P=HPG K:MBH H? MA> (14+. LRLM>F BL :<<>IM:;E> : <EHL>K EHHD :M MA> LRLM>F ?B@NK>L K>O>:EL MA:M MA> LRLM>F P> A:O> =>O>EHI>= MH MABL IHBGM <:GGHM ;> MK:=>= R>M (0:;E> 3.2). AEMAHN@A MA> LRLM>F H;OBHNLER LAHPL : ;B:L BG MA> IKB<>L :G= MA> MK:=BG@ LRLM>F BL KH;NLM MA> :O>K:@> MK:=>, PBMA $33, BL LMBEE GHM O>KR IKH?BM:;E>.

58

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

"NKMA>KFHK>, MA> LRLM>F LM:RL BG MA> F:KD>M 100% H? MA> MBF> ;><:NL> MA> >QBML :K> LMBEE FBLLBG@. AL : <HGL>JN>G<> MA> LRLM>F BL GHM NL>:;E> BG MABL LM:M> LBG<> MA> KBLDL PHNE= ;> MHH AB@A <HFI:K>= PBMA MA> IKHLI><MBO> K>MNKGL. 0A>K>?HK> BG MA> G>QM MPH <A:IM>KL P> PBEE ?NKMA>K >QM>G= HNK MK:=BG@ LRLM>F. "BKLM P> PBEE EHHD ?HK NL>?NE BGMK:=:R MBF> ?BEM>KL BG HK=>K MH BG<K>:L> MA> LRLM>F[L IKH?BM:;BEBMR. 0A> ?BG:E L><MBHG H? MABL <A:IM>K PBEE =>:E PBMA :==BG@ MA> G><>LL:KR >QBML.

3.4 Inserting an intraday time filter


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

Finding the best entry time


3> GHP I>K?HKF LRLM>F M>LML BG MA> ?HEEHPBG@ P:R. 3> M:D> HNK (14+. >GMKR ;NM P> K>LMKB<M MA> >GMKR MBF>L MH : LAHKM 4-AHNK MBF> PBG=HP >O>KR =:R. 3> PBEE LAB?M MA> LM:KMBG@ MBF> H? MA> PBG=HP BG LM>IL H? 30 FBGNM>L MAKHN@AHNM MA> =:R BG HK=>K MH ?BG= MA> ;>LM PBG=HP. ("HK MA> !:LR (:G@N:@> ,KH@K:FF>KL: RHN A:O> MH :== LHF> EBG>L BGMH MA> (14+.-<H=> :L LAHPG :;HO>, 0>QM 3.1, IHBGM 2, 0BF> 3BG=HP "BEM>K.)
3

0BF> BGO>LMB@:MBHGL :K> O:EN:;E> ?HK F:GR HMA>K F:KD>ML. /HF> H? RHN FB@AM A:O> K>:= HNK :KMB<E> BG T+ade+, F:@:SBG> 788 PA>K> P> IK>L>GM>= MPH LAHKM-M>KF MK:=BG@ LRLM>FL ;:L>= HG 5 FBGNM> :G= 20 FBGNM> BGMK:=:R =:M: ?HK MA> !NKHI>:G :G= 1/ /MH<D %G=>Q "NMNK>L.

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Trading Systems

"B@NK> 3.8 LAHPL MA> MHM:E G>M IKH?BM H? MA> MK:=BG@ LRLM>F :L : ?NG<MBHG H? MA> LM:KMBG@ MBF> H? MA> 4-AHNK MBF> PBG=HP. AG= MA> K>LNEM BL K>:EER LB@GB?B<:GM! 5HN L>> MA:M MA> IKH?BM H? HNK MK:=BG@ LRLM>F AB@AER =>I>G=L HG MA> <AHL>G MBF> PBG=HP. 3A>G RHN LM:KM MK:=BG@ ?KHF 5IF NGMBE 3:F #K>>GPB<A )>:G 0BF> (#)0) MA> MK:=BG@ LRLM>F EHL>L FHG>R, PA>K>:L BM BL :;E> MH @:BG AB@A IKH?BML =NKBG@ #)0 =:R MBF>, >LI><B:EER BG MA> FHKGBG@ ;>MP>>G 8:F :G= 12:F.
Figure 3.8: Total Net Profit as a function of the entry time of a 4-hour time window. LUXOR system, tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. SLOW=44, FAST=1. Calculation incl. $30 S+C per RT. No exits are in place.

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How to develop a trading system step-by-step using the example of the British pound/US dollar pair

Result with added time filter


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Trading Systems

Figure 3.9: LUXOR system results with added time filter. Entries only allowed in the 4-hour time window from 9.30am1.30pm GMT. A: detailed equity curve. B: weekly underwater equity curve. British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Optimised input parameters in terms of net profit: SLOW=44, FAST=1. Test without exits. Back-test includes $30 slippage and commission. Charts from TradeStation 8.

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How to develop a trading system step-by-step using the example of the British pound/US dollar pair

Table 3.3: Main system figures of the LUXOR system with added time filter: Entries only allowed in the 4-hour time window from 9.30am 1.30pm GMT. British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Optimised input parameters: SLOW=44, FAST=1. System without exits, always in the market, long or short. Back-test includes $30 slippage and commission.

All Trades
Total Net Profit Gross Profit Gross Loss Profit Factor Total Number of Trades Percent Profitable Winning Trades Losing Trades Avg. Trade Net Profit Avg. Winning Trade Avg. Losing Trade Ratio Avg. Win:Avg. Loss Largest Winning Trade Largest Losing Trade Max. Consecutive Winning Trades Max. Consecutive Losing Trades Avg. Bars in Total Trades Avg. Bars in Winning Trades Avg. Bars in Losing Trades Total Slippage Total Commission Percent of Time in the Market Max. Drawdown (Intra-day Peak to Valley) Date of Max. Drawdown $115,502 $428,864 ($313,362) 1.37 902 42.02% 379 523 $128 $1,132 ($599) 1.89 $6,748 ($2,531) 6 13 78.82 116.73 51.34 $18,040 $9,020 99.92% $18,894 24-May-06

Long Trades
$82,050 $226,323 ($144,273) 1.57 451 44.79% 202 249 $182 $1,120 ($579) 1.93 $6,748 ($2,531) 7 8 78.44 113.29 50.16 $9,020 $4.510

Short Trades
$33,452 $202,541 ($169,089) 1.2 451 39.25% 177 274 $74 $1,144 ($617) 1.85 $5,728 ($2,442) 6 11 79.2 120.66 52.41 $9,020 $4.510

$9,402

$17,378

BNM BG LIBM> H? MA>L> IKHFBLBG@ MK:=> ?B@NK>L MA> LRLM>F LMBEE A:L LHF> F:CHK P>:D IHBGML.

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Trading Systems

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

3.5 Determination of appropriate exits risk management


L(($ a- "- -!", 0a2: 0!e-!e+ 2(.+ -+ad"' ,2,-e& +e,e&b%e, a .',%"' e+ ,!((-"' f+(& -!e !") (+ a 0e%%-a"&ed ,'")e+ %2"' "' a&b.,!, $'(0"' 0!e+e 2(.+ -+ade, a+e !ead"' c(.%d &ea' -!e d"ffe+e'ce be-0ee' +"d"' "'-( -!e ,.',e- (+ %2"' fa-a%%2 0(.'ded (' a d.,-2 ,-+ee- a- !" !-'(('. T( ,-a2 a%"/e 2(. &.,- $'(0 0!e' -( d+a0 a'd 0!e' -( +.'.
0AHF:L /MKB=LF:G 718

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
64

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

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
Figure 3.10: The Dynamic of Exits. In the phase of low volume and low volatility different exits are needed than in the phase of increasing volume with the short breakout. Chart example was taken from Light Crude Oil, 5 minute, NYMEX from 22 August 2008. Chart and datafeed from TradeStation 8.

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Trading Systems

The concept of Maximum Adverse Excursion (MAE)


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

66

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

Figure 3.11: The MAE graph of LUXOR system. Green: winning trades, red: losing trades. System tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. Input parameters SLOW=44, FAST=1. Without exits, always in the market, including $30 S+C per RT. Diagram created with TradeStation 8.

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Trading Systems

Figure 3.12A: MAE graph in percentage terms. Green up arrows = winning trades, red down arrows = losing trades. Trend-following system British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. Input parameters SLOW=44, FAST=1. Without exits, always in the market, including $30 S+C per RT. Diagram created with TradeStation 8.

Figure 3.12B: Maximum Adverse Excursion graph in percentage terms after inserting a 0.3% stop loss into the system. LUXOR system tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. Input parameters SLOW=44, FAST=1. Diagram created with TradeStation 8.

68

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

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

69

Trading Systems

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

Inserting a risk stop loss


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

70

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

Figure 3.13: Ratio of total net profit/maximum intraday drawdown as a function of the stop loss distance in per cent. LUXOR system tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. Including $30 S+C per RT.

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

71

Trading Systems

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
Figure 3.14A: Detailed equity curve, B: underwater equity curve with 0.3% risk stop loss in place. LUXOR system tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/20024/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. Including 30 $ S+C per RT. Charts from TradeStation 8.

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How to develop a trading system step-by-step using the example of the British pound/US dollar pair

DrawDown (%)

11/30/03

1/23/05

3/12/06

4/29/07

6/15/08

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
73

Trading Systems

Adding a trailing stop


A MK:BEBG@ LMHI BL : LMHI HK=>K PAB<A :=:IML MH MA> <NKK>GM F:KD>M IKB<>. %G MA> <:L> H? : G>P EHG@ IHLBMBHG BM BL BGBMB:EER L>M :M : ?BQ>= I>K<>GM:@> ;>EHP MA> >GMKR IKB<>. %? MA> F:KD>M IKB<> KBL>L, MA> MK:BEBG@ LMHI IKB<> KBL>L IKHIHKMBHG:M>ER, ;NM B? MA> IKB<> ?:EEL, MA> MK:BEBG@ LMHI IKB<> =H>LG[M <A:G@> ("B@NK> 3.15A).
Figure 3.15A: The principle of a trailing stop. Chart example from British pound/US dollar (FOREX), 30 minute bars, September 2008. Chart from TradeStation 8.

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

74

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

;>EHP 0.2% E>:= MH : =BL:LM>K. $HP>O>K ?KHF 0.2 MH 0.5% MA> K>LNEML BG<K>:L> LM>:=BER :G= ;>MP>>G 0.5% :G= 1% RHN ?BG= : ;KH:= K>@BHG H? MK:BEBG@ LMHIL PAB<A BG<K>:L> MA> LRLM>F[L *,/ K:MBH. %? RHN L>M MA> MK:BEBG@ LMHIL >O>G PB=>K MA>G MA> K:MBH <HGO>K@>L MH MA> *,/ K:MBH H? MA> MK:=BG@ LRLM>F PBMAHNM :G :==>= MK:BEBG@ LMHI. 0A> LMHI =BLM:G<> ;><HF>L LH ;B@ MA:M ?>P>K :G= ?>P>K MK:=>L :K> :??><M>= ;R BM.
Figure 3.15B: Ratio of total net profit/maximum intraday drawdown as a function of the distance of an added trailing stop. Risk stop loss of 0.3% kept in place. LUXOR system tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. Including $30 S+C per RT.

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Trading Systems

3BMA MA> MPH MRI>L H? LMHIL BG IE:<> P> PBEE GHP <A><D B? BGL>KMBG@ IKH?BM M:K@>ML PBEE ?NKMA>K BFIKHO> MA> MK:=BG@ LRLM>F.

Looking for profit targets: Maximum Favourable Excursion (MFE)


&HAG /P>>G>R[L <HG<>IM H? )"! BL <HFIE>F>GM:KR MH )A!. )"! BL =>?BG>= :L MA> FHLM IHLBMBO> IKB<> FHO>F>GM ?HK RHNK IHLBMBHG. %M MA>K>?HK> <HKK>LIHG=L MH MA> AB@A>LM HI>G >JNBMR PBMABG MA> EB?>LI:G H? : MK:=>. 3A>K>:L )A! P:L NL>?NE MH BGO>LMB@:M> RHNK MK:=>L[ =K:P=HPGL :G= MH L>M : @HH= LMHI EHLL, )"! K>O>:EL MA>BK KNG-NIL :G= A>EIL MH ?BG= NL>?NE IKH?BM M:K@>ML ("B@NK> 3.16).
Figure 3.16: The MFE graph shows the realised profit/loss vs. run-ups of all trades. Green: winning trades, red: losing trades. LUXOR system tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with 0.3% risk stop and 0.8% trailing stop. Input parameters SLOW=44, FAST=1, including $30 S+C per RT. Diagram created with TradeStation 8.

76

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

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

77

Trading Systems

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
Figure 3.17: Ratio of total net profit/maximum intraday drawdown as a function of the distance of an added profit target. Risk stop loss of 0.3% and trailing stop of 0.8% are kept in place during tests. LUXOR system tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. Including. $30 S+C per RT.

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How to develop a trading system step-by-step using the example of the British pound/US dollar pair

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

Summary: Result of the entry logic with the three added exits
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Trading Systems

Figure 3.18: LUXOR system with all three exits in place: 0.3% risk stop, 0.8% trailing stop and 1.9% profit target, tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. Including $30 S+C per RT. A: detailed equity curve, B: end of month equity curve, C: average profit per month. Charts created with TradeStation 8.

Equity ($)

Net Profit ($)

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How to develop a trading system step-by-step using the example of the British pound/US dollar pair

Net Profit ($)

Months

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Trading Systems

Table 3.4: How additional exits change the result of the LUXOR system; change of trading figures of the system tested on British pound/US dollar (FOREX), with one exit added after another, 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. Including $30 S+C per RT.

With Stop loss With Stop Loss 0.3% and Trail Without Exit 0.3% Stop 0.8% Total Net Profit Gross Profit Gross Loss Profit Factor Total Number of Trades Percent Profitable Winning Trades Losing Trades Avg. Trade Net Profit Avg. Winning Trade Avg. Losing Trade Ratio Avg. Win:Avg. Loss Largest Winning Trade Largest Losing Trade Max. Consecutive Winning Trades Max. Consecutive Losing Trades Avg. Bars in Total Trades Avg. Bars in Winning Trades Avg. Bars in Losing Trades Percent of Time in the Market Max. Drawdown (Intraday Peak to Valley) Date of Max. Drawdown Total Slippage and Commission $115,502 $428,864 ($313,362) 1.37 902 42.02% 379 523 $128 $1,132 ($599) 1.89 $6,748 ($2,531) 6 13 78.82 116.73 51.34 99.92% ($18,894) 24-May-06 $27,060 $116,209 $399,440 ($283,232) 1.41 1025 34.34% 352 673 $113 $1,135 ($421) 2.7 $6,748 ($810) 5 12 52.81 108.74 23.56 73.56% ($11,266) 24-Feb-06 $30,750 $126,772 $405,347 ($278,576) 1.46 1040 35.38% 368 672 $122 $1,101 ($415) 2.66 $7,510 ($810) 6 12 49.47 100.75 21.39 69.98% ($10,292) 24-Feb-06 $31,200

With Stop loss 0.3% and Trail Stop 0.8% and Profit Target 1.9% $132,590 $414,533 ($281,944) 1.47 1051 35.20% 370 681 $126 $1,120 ($414) 2.71 $3,900 ($810) 6 12 46.79 93.42 21.45 66.70% ($10,292) 24-Feb-06 $31,530

Left column: system without exits Second column: system with 0.3% risk stop loss Third column: system with 0.3% risk stop and a 0.8% trailing stop Right column: system with 0.3% risk stop, 0.8% trailing stop and 1.9% profit target
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How to develop a trading system step-by-step using the example of the British pound/US dollar pair

How exits are affected by money management


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
Figure 3.19: Scatter graph of profits for all generated trades of the LUXOR system. Tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. Including $30 S+C per RT. A: without added exits. B: with 0.3% risk stop loss (red line), 1.9% profit target (green line) and 0.8% trailing stop. The exits act like borders for the trade distribution. Graphs created with TradeStation 8.

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Trading Systems

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

84

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

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

85

Trading Systems

Figure 3.20: How the Exits prepare for Money Management. MFE diagram of all trades. How risk stop loss and trailing stops affect the trade distribution and make trades more calculable. Graph created with TradeStation 8.

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

3.6 Summary: Step-by-step development of a trading system


%G MABL <A:IM>K P> A:O> LAHPG BG MA> >Q:FIE> H? MA> #B,/1/ <NKK>G<R I:BK AHP MH =>O>EHI : G>P MK:=BG@ LRLM>F LM>I-;R-LM>I ("B@NK> 3.21). !O>KR MK:=BG@ LRLM>F LM:KML PBMA :G B=>: :G= : LHNG= EH@B<. 0A> B=>: ?HK HNK MK:=BG@ LRLM>F (14+. P:L M:D>G ?KHF MA> /0A 0K:=>/M:MBHG >O>EHIF>GM CEN; ;NM MA>K> :K> F:GR HMA>K @HH= LHNK<>L H? B=>:L BG<EN=BG@ ;HHDL, MA> BGM>KG>M :G= L>FBG:KL. +G<> RHN A:O> ?HNG= MA> B=>:, RHN A:O> MH

86

How to develop a trading system step-by-step using the example of the British pound/US dollar pair

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
Figure 3.21: Step-by-step development of a trading system. From an idea to a final system including entries, exits, trading costs etc.

87

4
Two methods for evaluating the systems predictive power
3O'ce 2(. !a/e a ,2,-e&, -!e b"
Tom Wills

e,- (b,-ac%e ", -+.,-"' "-.4

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

89

Trading Systems

4.1 Timescale analysis

Changing the compression of the price data


%G HK=>K MH I>K?HKF : M>LM P> G>>= MH A:O> =:M: MA:M P:L GHM NL>= =NKBG@ MA> ;NBE=BG@ :G= MA> =>O>EHIF>GM H? MA> MK:=BG@ LRLM>F. 0ABL =:M: BL <:EE>= HNM-H?-L:FIE> =:M:. 0A> LBFIE>LM P:R MH @>M LN<A HNM-H?-L:FIE> =:M: ?HK RHNK MK:=BG@ LRLM>F BL CNLM :IIER BM MH MA> L:F> F:KD>M :G= MA> L:F> =:M: ;NM MH <A:G@> MA> MBF>L<:E>. AEMAHN@A BG MABL P:R MA> G>P MBF>L<:E> BL GHM K>:EER =B??>K>GM, BML IKB<> LMKN<MNK> <A:G@>L : EHM PBMABG =BO>KL> MBF>L<:E>L. 0A>K>?HK> F:GR O:EN:;E> MK:=BG@ LRLM>FL PAB<A PHKD P>EE HG HG> MBF>L<:E> ?:BE <HFIE>M>ER HG :GHMA>K L<:E> BG MA> L:F> F:KD>M. AL ?:K :L MA> MK:=BG@ LRLM>F (14+. BL <HG<>KG>=, ?HK MBF>L<:E> :G:ERLBL, RHN ?BKLM =>O>EHI :G= M>LM : MK:=BG@ LRLM>F LM>I-;R-LM>I HG HG> MBF>L<:E>, EBD> P> =B= HG 30 FBGNM> =:M:. 5HN =>O>EHI MA> >GMKB>L, RHN :== MK:=BG@ <HLML, MA>G MAKHN@A HIMBFBL:MBHG :G= ?BEM>KBG@ RHN PBEE :KKBO> :M : <HFIE>M> LRLM>F PBMA LMHIL :G= IKH?BM M:K@>ML. 0A>G RHN CNLM M:D> MABL PAHE> MK:=BG@ LRLM>F :G= :IIER BM EBD> BM BL MH MA> L:F> F:KD>M HG =B??>K>GM MBF>L<:E>L. 3BMA MH=:R[L LH?MP:K> IE:M?HKFL EBD> 0K:=>/M:MBHG 8 LN<A LRLM>F M>LML <:G ;> I>K?HKF>= O>KR >:LBER. 5HN D>>I :EE RHNK :IIEB>= LMK:M>@B>L HG MA> <A:KM PABE> <A:G@BG@ MA> LRF;HE IKHI>KMB>L: BG MABL <:L> RHN :K> <A:G@BG@ MA> ;:K E>G@MA ?KHF 30 FBGNM> MH :GR HMA>K, ?HK >Q:FIE> 5 FBGNM>, 10 FBGNM>, 120 FBGNM>, =:BER >M<. %? RHN I>K?HKF LN<A : <A:G@> RHN L>> MA:M MA> <A:KM :G= MA> BG=B<:MHKL PAB<A RHN NL> ?HK LB@G:E @>G>K:MBHG EHHD O>KR LBFBE:K, :EMAHN@A RHN :K> PHKDBG@ HG =B??>K>GM MBF>L<:E>L ("B@NK> 4.1). /BG<> MA> BG=B<:MHKL, BG HNK <:L> MA> MPH FHOBG@ :O>K:@>L, :K> <:E<NE:M>= HG MA> ;:LBL H? MA> <A:KM ;:KL, BM =H>L GHM F:MM>K O>KR FN<A B? MA> ;:KL :K> <:E<NE:M>= >O>KR 5 FBGNM>L, 30 FBGNM>L HK 120 FBGNM>L. BNM :EMAHN@A MA> IKHI>KMB>L H? LHF> BG=B<:MHKL EHHD LBFBE:K, MA> F:KD>M BG ?:<M ;>A:O>L O>KR =B??>K>GMER PA>G EHHDBG@ :M BML =B??>K>GM MBF>L<:E>L BG FHK> =>M:BE. '>>I BG FBG= MA:M HG MA> 5 FBGNM> L<:E> RHN P:M<A MA> IKB<> =:M: HO>K 5 R>:KL FN<A FHK> <EHL>ER MA:G HG E:K@>K MBF>L<:E>L EBD> MA> 120 FBGNM> MBF>?K:F>. 3A>K>:L BG MA> 120 FBGNM> MBF>L<:E> 120 ;:KL F>:G A:E? : FHGMA H? IKB<> =:M:, MA> L:F> :FHNGM H? ;:KL HG : 5 FBGNM> MBF>L<:E> CNLM <HGM:BGL A:E? : =:R ("B@NK> 4.1).

90

Two methods for evaluating the systems predictive power

Figure 4.1 British pound/US dollar FOREX on different timescales: A: 5 minute bars, B: 30 minute bars, C: 120 minute bars. Chart examples from July 2008. The two moving averages like all other parameters for signal generation are kept the same while changing the timescale of the chart. Each of the three figures shows about 100-150 bars.

91

Trading Systems

LUXOR tested on different bar compressions


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

92

Two methods for evaluating the systems predictive power

Figure 4.2 Detailed equity curves from system tests on different timescales from 5 minute up to 180 minute bar calculations. Trend-following system British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. All three exits in place: 0.3% risk stop, 0.8 trailing stop and 1.9% profit target. Including $30 S+C per RT.

93

Trading Systems

94

Two methods for evaluating the systems predictive power

95

Trading Systems

AEMAHN@A MA> MK:=BG@ LRLM>F F:D>L IKH?BML HG :EE MA> =B??>K>GM MBF>L<:E>L, MA> LA:I>L H? MA> >JNBMR <NKO>L PBMA MA>BK =K:P=HPG IA:L>L :II>:K : ;BM =B??>K>GM.

Net profit and maximum drawdown dependent on the traded bar length
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

96

Two methods for evaluating the systems predictive power

Figure 4.3: Timescale analysis. Total net profit and maximum drawdown as a function of the bar length. Trend-following system British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am- 1.30pm GMT. SLOW=44, FAST=1. All three exits in place: 0.3% risk stop, 0.8 trailing stop and 1.9% profit target. Including $30 S+C per RT.

Explanation for the time dependency of the system


3A:M :K> MA> K>:LHGL ?HK MA> LRLM>F[L MHM:E G>M IKH?BM MBF> =>I>G=>G<R? 0H NG=>KLM:G= MABL RHN G>>= MH K>FBG= RHNKL>E? MA:M MA> MHM:E G>M IKH?BM H? : MK:=BG@ LRLM>F BL MA> GNF;>K H? :EE MK:=>L FNEMBIEB>= PBMA MA> :O>K:@> IKH?BM I>K MK:=> ("B@NK> 4.4). "HK >Q:FIE> E>M[L L:R MA:M RHN A:O> : MK:=BG@ LRLM>F PAB<A @>G>K:M>L 1000 MK:=>L. %G MABL <:L> :G :O>K:@> IKH?BM I>K MK:=> H? $100 E>:=L MH : MHM:E G>M IKH?BM H? $100,000 (1000 Q $100).

97

Trading Systems

Figure 4.4: The total net profit of a trading system is the product of two factors: number of trades and average profit per trade.

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

98

Two methods for evaluating the systems predictive power

Figure 4.5: Timescale analysis. Number of generated trades as a function of the bar length. Trend-following system British pound/US dollar (FOREX), 30 minute bars, 21/10/20024/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. All three exits in place: 0.3% risk stop, 0.8 trailing stop and 1.9% profit target. Including $30 S+C per RT.

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

99

Trading Systems

Figure 4.6: Timescale analysis. Average profit per trade as a function of the bar length. Trendfollowing system British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. All three exits in place: 0.3% risk stop, 0.8 trailing stop and 1.9% profit target. Including $30 S+C per RT.

"KHF MA> O:KB:MBHG H? MA> MHM:E GNF;>K H? MK:=>L :G= :O>K:@> IKH?BM I>K MK:=> =>I>G=BG@ HG MA> L>E><M>= ;:K E>G@MA RHN <:G <HG<EN=> AHP MA> MHM:E G>M IKH?BM O:KB>L PBMA <A:G@BG@ MBF>L<:E>. +G MA> O>KR LAHKM MBF>L<:E>L MA> MHM:E G>M IKH?BM LN??>KL ?KHF : MHH EHP IKH?BM I>K MK:=>. BNM :EK>:=R PBMA MBF>L<:E>L EHG@>K MA:G 5 FBGNM>L MA> EHP :O>K:@> IKH?BM I>K MK:=> <:G ;> <HFI>GL:M>= PBMA MA> AB@A>K GNF;>K H? MK:=>L :G= E>:=L MA> MK:=BG@ LRLM>F MH : AB@A MHM:E G>M IKH?BM PBMA EHP F:QBFNF =K:P=HPG. %? RHN BG<K>:L> MA> MBF>L<:E> ?NKMA>K, :;HO> 40 FBGNM>L :G= FHK>, MA> MHM:E G>M IKH?BM ;><HF>L EHP>K :G= EHP>K LBG<> E>LL :G= E>LL MK:=>L :K> @>G>K:M>= PABE> MA> LBG@E> MK:=> IKH?BM =H>L GHM BG<K>:L>. AL : <HGL>JN>G<> HNK MK:=BG@ LRLM>F PHKDL ;>LM BG MA> F>=BNF MBF>L<:E>L ;>MP>>G 10 :G= 35 FBGNM>L. *HP PA:M =H :EE MA>L> ?BG=BG@L F>:G ?HK MA> IK>=B<MBO> IHP>K H? HNK MK:=BG@ LRLM>F? 0A> MK:=BG@ LRLM>F PAB<A P:L =>O>EHI>= :G= HIMBFBL>= HG MA> 30 FBGNM> MBF>L<:E> LAHPL IKHFBLBG@ K>LNEML NG=>K O:KB:MBHG H? MA> MBF>L<:E>. "KHF MA>L> K>LNEML PBMA MA> IKHO>G LM:;BEBMR RHN <:G =K:P MA> <HG<ENLBHG MA:M MA> MK:=BG@ EH@B< A:L : @HH= <A:G<> H? LM:G=BG@ NI MH ?NKMA>K HNM-H?-L:FIE> =:M: M>LML :G= <:G ;> IKH?BM:;E> BG K>:E MK:=BG@.

100

Two methods for evaluating the systems predictive power

4.2 Monte Carlo analysis

3W!a- ", -!e %a,- -!"' 2(. d( bef(+e 2(. c%"&b (' a %adde+? Y(. ,!a$e "-. A'd -!a", M('-e Ca+%( ,"&.%a-"('.4
Sam Savage, Stanford University [10]

*>:KER >O>KR;H=R A:L A>:K= H? BM, ;NM GH;H=R NL>L BM. ):GR I>HIE> :K> :?K:B= MA:M )HGM> C:KEH :G:ERLBL BL LN<A : <HFIE>Q F>MAH= MA:M BG HK=>K MH NG=>KLM:G= BM RHN FNLM ;> : IKH?>LLHK BG F:MA>F:MB<L. $HP>O>K MA> MKNMA BL MA:M BM BL GHM MA:M =B??B<NEM :G= BM LAHNE= ;> NL>= ;R >O>KR;H=R PAH P:GML MH =H FHK> MA:G CNLM MH EHHD :M MA> @:BG>= >JNBMR EBG>L H? LRLM>F ;:<D-M>LML.

The principle of Monte Carlo analysis


BNM PA:M =H>L /:F /:O:@> F>:G PA>G A> L:RL MA:M )HGM> C:KEH :G:ERLBL BL CNLM : M><AGBJN> MH LA:D> : E:==>K ;>?HK> <EBF;BG@ HG BM? 0H NG=>KLM:G= ABL L>GM>G<> RHN ?BKLM FNLM DGHP PA:M MA> E:==>K BL :G= PA:M <:G ;> LA:D>G HG BM. AL RHN IKH;:;ER :LLNF>, BG HNK <:L> MA> E:==>K BL : MK:=BG@ LRLM>F. "B@NK> 4.7 LAHPL MABL E:==>K, MA> =>M:BE>= >JNBMR <NKO> H? MA> MK:=BG@ LRLM>F (14+., PBMA :EE ?BEM>KL :G= >QBML :IIEB>= :L >QIE:BG>= BG CA:IM>K 3.

101

Trading Systems

Figure 4.7: Detailed Equity Curve of system LUXOR. Tested on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. With entry time window 9.30am-1.30pm GMT. SLOW=44, FAST=1. All three exits in place: 0.3% risk stop, 0.8% trailing stop and 1.9% profit target. Including $30 S+C per RT. Calculation based on one contract basis, results incl. $30 slippage and commissions per trade. Chart created with Market System Analyzer (see www.adaptrade.com).

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

102

Two methods for evaluating the systems predictive power

Figure 4.8: The principle of Monte Carlo analysis: A trading system which contains six trades is shaken this means that the positions of the six trades are exchanged accidentally.

5HN <:G =H BM BG MA> L:F> P:R PBMA >O>KR :K;BMK:KR GNF;>K H? MK:=>L. 0A> G>P IHLBMBHGL H? MA> MK:=>L :K> =>M>KFBG>= K:G=HFER. "HK >Q:FIE>, BG HNK LRLM>F MK:=> 1 BL GHP BG IHLBMBHG 842, MK:=> 2 BG IHLBMBHG 66, MK:=> 1051 BG IHLBMBHG 980 >M<. 0A> BFIHKM:GM IHBGM BL MA:M >O>KR MK:=> LMBEE >QBLML EBD> ;>?HK> W GH MK:=> BL =>E>M>= :G= GH MK:=> BL :==>=. 0ABL I>KFNM:MBHG F>MAH= BL <:EE>= XL>E><MBHG PBMAHNM K>IE:<>F>GMY4.

AGHMA>K IHLLB;E> I>KFNM:MBHG F>MAH= BL L>E><MBHG PBMA K>IE:<>F>GM. 0A> :=O:GM:@> H? : L>E><MBHG PBMAHNM K>IE:<>F>GM BL MA:M BM >Q:<MER =NIEB<:M>L MA> IKH;:;BEBMR =BLMKB;NMBHG H? MA> BGINM L>JN>G<>, PA>K>:L L>E><MBHG PBMA K>IE:<>F>GM F:R GHM. 0A> =K:P;:<D MH L>E><MBHG PBMAHNM K>IE:<>F>GM BL MA:M MA> K:G=HFER L:FIE>= MK:=> L>JN>G<>L :K> EBFBM>= MH MA> GNF;>K H? MK:=>L BG MA> BGINM L>JN>G<>. 0ANL B? RHN A:O> : LAHKM L>JN>G<> H? MK:=>L (>.@. E>LL MA:G 50 MK:=>L), MABL F:R EBFBM MA> :<<NK:<R H? RHNK <:E<NE:MBHGL. 0A> ?BKLM F>MAH= BL LBFBE:K MH K:G=HF L>E><MBHG PBMA K>IE:<>F>GM PBMA MA> :=O:GM:@> MA:M MA> ?BG:E EBLM H? MK:=>L PBEE A:O> MA> L:F> LM:MBLMB<:E IKHI>KMB>L :L MA> HKB@BG:E EBLM. 0A> L><HG= F>MAH= BGMKH=N<>L FHK> K:G=HFG>LL BGMH MA> MK:=> L>JN>G<>, PAB<A F:R ;> IK>?>K:;E> B? MA> >QI><M>= MK:=>L BG MA> ?NMNK> PBEE EBD>ER ;> =B??>K>GM MA:G MAHL> H? MA> HKB@BG:E L>JN>G<>.
4

103

Trading Systems

Exchanging the order of the performed trades


0A> :;HO> >Q:FIE> LN@@>LML MA:M MA> ?BG:E HNM<HF> H? :EE MK:=>L FNLM LM:R MA> L:F>, BG=>I>G=>GM H? PA:M>O>K G>P HK=>K MA> MK:=>L :K> IE:<>= BG. /BG<> MA> LNF H? RHNK MK:=>L LM:RL MA> L:F> :EE G>P >JNBMR <NKO>L FNLM K>:<A MA> L:F> :FHNGM BG MA> >G=. BNM LBG<> MA> MK:=>L :K> GHP BG : G>P HK=>K, MA> LA:I> H? MA> G>P >JNBMR EBG>L :G= >LI><B:EER MA> H<<NKKBG@ =K:P=HPGL ;><HF> =B??>K>GM ("B@NK> 4.9).
Figure 4.9: Blue: detailed equity curve, Black: 15 permutations of the trades sequence (shaken trades). Trend-following system LUXOR British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Calculation based on one contract basis, results including $30 slippage and commissions per trade.

0ABL ?B@NK> LAHPL MA> HKB@BG:E MK:=> L>JN>G<> (MAB<D ;EN> EBG>) :G= 15 I>KFNM>= MK:=> L>JN>G<>L (MABG ;E:<D EBG>L). AEE MA> I>KFNM:M>= >JNBMR <NKO>L A:O> MA> L:F> LM:KMBG@ :G= >G=BG@ IHBGML ;><:NL> P> =B= GHM :== HK K>FHO> :GR MK:=>L ;NM CNLM <A:G@>= MA> HK=>K H? MA>BK :II>:K:G<>. 0A> <A:G@> H? MA> MK:=> HK=>KL E>:=L MH MA> >??><M MA:M ;>MP>>G MA> >JNBMR <NKO>L MA>K> :K> ;B@ O:KB:MBHGL PBMA =B??>K>GM =K:P=HPG IA:L>L MA:M H<<NK :M =B??>K>GM MBF>L.

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Two methods for evaluating the systems predictive power

Probabilities and confidence levels


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

0A> ?BKLM MK:=> RHN <:G INM HG 1051 =B??>K>GM IHLBMBHGL, MA> L><HG= MK:=> A:L 1050 IHLBMBHGL E>?M, MA> MABK= MK:=> 1049 IHLBMBHGL :G= LH HG: 1051*1050*V*2*1 IHLLB;BEBMB>L.
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Trading Systems

Figure 4.10: Gaussian distribution of probabilities for flipping a coin 1000 times. You can tell with 95% confidence that the coin falls to heads between 469 and 531 times. Figure created with MATLAB.

0A>L> <HG?B=>G<> E>O>EL (>.@. 95%, 99% <HG?B=>G<> >M<) :K> NL>= BG )HGM> C:KEH :G:ERLBL.

106

Two methods for evaluating the systems predictive power

Performing a Monte Carlo analysis with the LUXOR trading system


(>M[L EHHD :M MA> <HG<K>M> >Q:FIE> H? : )HGM> C:KEH :G:ERLBL H? HNK MK:=BG@ LRLM>F (14+. (0:;E> 4.1).
Table 4.1: Monte Carlo analysis of 5000 permutations with worst case maximum drawdown and average drawdown as a function of confidence level. Trend-following system LUXOR British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Calculation based on one contract basis, results including $30 slippage and commissions per trade. Calculation performed with Market System Analyzer.

Test period: Market Costs: Number of samples for Monte Carlo Analysis Total Net Profit Final Account Equity Total Number of Trades Number of Winning Trades Number of Losing Trades Largest Winning Trade Average Winning Trade Largest Losing Trade Average Losing Trade

21/10/2002-4/7/2008 GBP/USD, 30 min bars 30$ Slipp. + Comm. 5000 $132,589.50 $142,589.50 1,051 370 681 $3,900.00 $1,120.36 ($810.00) ($414.01) Worst Case Max. Drawdown Worst Case Average Drawdown ($1,976) ($2,006) ($2,040) ($2,090) ($2,176) ($2,259) ($2,308)

ORIGINAL SYSTEM MONTE CARLO results at 60% confidence MONTE CARLO results at 70% confidence MONTE CARLO results at 80% confidence MONTE CARLO results at 90% confidence MONTE CARLO results at 95% confidence MONTE CARLO results at 99% confidence

($10,292) ($12,321) ($13,222) ($14,325) ($16,136) ($17,908) ($21,364)

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Trading Systems

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

Limitations of the Monte Carlo method


%? RHN P:GM MH >LMBF:M> MA> K>:E KBLDL PAB<A :K> AB==>G ;>EHP MA> K>LNEML H? RHNK I>K?HKF:G<> M:;E>, )HGM> C:KEH :G:ERLBL BL MA> KB@AM F>MAH=. BNM PA>G =K:PBG@ <HG<ENLBHGL ?KHF )HGM> C:KEH <:E<NE:MBHGL RHN LMBEE FNLM D>>I BG FBG= MA> :LLNFIMBHGL HG PAB<A MA>R :K> ;:L>= :G= MA>BK EBFBM:MBHGL. 0A> =:G@>KHNL IHBGM BL MA:M ?HK MA> )HGM> C:KEH :G:ERLBL RHN M:D> MA> MK:=>L ?KHF MA> MK:=BG@ EH@B< :L RHN @>M MA>F ?KHF RHNK ;:<DM>LML. BNM PA:M B? MABL MK:=BG@ EH@B< BL HGER <NKO> ?BMM>= :G= HO>K-HIMBFBL>=? 0A> )HGM> C:KEH :G:ERLBL <:GGHM L>> MABL! /BG<> BM CNLM M:D>L MA> MK:=>L H? RHNK LRLM>F (PAB<A FB@AM ;> HO>K-?BMM>=) BM NLN:EER LAHPL : @HH= K>LNEM B? MA> ;:<D-M>LM BL @HH=. +G MA> HMA>K LB=> BM LAHPL ;:= K>LNEML HGER B? MA> ;:<D-M>LM BL ;:=.
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Two methods for evaluating the systems predictive power

/H )HGM> C:KEH :G:ERLBL BL HGER NL>?NE PA>G :IIEB>= <HKK><MER :G= GHM MH HO>K-?BMM>= MK:=BG@ LRLM>FL. AG= LMBEE, >O>G B? BM BL :IIEB>= <HKK><MER, RHN G>>= MH ;> <:K>?NE BG BML BGM>KIK>M:MBHG. /HF>MBF>L MABG@L HG MA> F:KD>ML M:D> IE:<> PAB<A <:GGHM ;> :OHB=>=:
AG= LHF> >O>GML :K> ;>RHG= MA> FH=>E[L :;BEBMR MH IK>=B<M MA>F. 0A> ;K:BGR LHKML :M (HG@0>KF C:IBM:E ):G:@>F>GM, MA> A>=@> ?NG= MA:M BFIEH=>= =NKBG@ 1998, >FIEHR>= LHIABLMB<:M>= IKH;:;BEBMR FH=>EL. BNM MAHL> FH=>EL ?:BE>= =K:F:MB<:EER =NKBG@ : ?BG:G<B:E <:E:FBMR MA:M P:L MKB@@>K>= ;R : =>?:NEM BG .NLLB:. 0A:M[L : P:KGBG@ MA:M MABL AB@A-M><A IE:GGBG@ BL GHM ?HHEIKHH?. )R <HG<>KG BL MA:M I>HIE> :K> NLBG@ )HGM> C:KEH :L : <>KM:BGMR M>LM. %M BLG[M. %M[L : IKH;:;BEBMR M>LM. 7108

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Trading Systems

Figure 4.11: Daily changes of the British pound vs. US dollar in percent from August 1988August 2008. Biggest gain was 2.8%, biggest loss 3.3%. The Gaussian distribution cannot describe the daily changes exactly, especially for large gains and losses (encircled areas). Figure generated with MATLAB, data taken from TradeStation 8.

110

5
The factors around your system
):GR MK:=>KL ;>EB>O> MA:M MA> LRLM>F <H=> BL PA:M <HNGML BG ;><HFBG@ : LN<<>LL?NE MK:=>K. %G ?:<M MA> <H=> BL MA> least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ide#cedBa'ed Tech#ica! A#a!,'i' 728. 3> M:D> BM A>K> :L HNK F:BG K>?>K>G<> :G= P> PBEE EHHD :M MA> MHIB< ?KHF : IK:<MB<:E IHBGM H? OB>P PBMA K>:E >Q:FIE>L H? MK:=BG@ LRLM>FL.

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Trading Systems

5.1 The markets long/short bias


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

The trend is your friend?


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

112

The factors around your system

Figure 5.1: British pound/US dollar (FOREX), weekly bars, 1/7/2002-4/7/2008. A long entry signal is placed on 21/10/2002.

Figure 5.2: Only long trading system for British pound/ US dollar (FOREX), 1/7/2002-4/7/2008. A long entry signal is placed on 21/10/2002 and the system stays in the market all the time. A: detailed equity curve; B: underwater equity curve showing all drawdowns.

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Trading Systems

Consequences for system development


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
114

The factors around your system

BL FHK> LM:;E> :G= E>LL :=:IM>= MH MABL F:KD>M ;B:L B? BM IKH=N<>L MA> L:F> :FHNGM H? EHG@ :G= LAHKM LB@G:EL.

5.2 Out-of-sample deterioration


:OB= AKHGLHG LM:M>= : ?:<M PAB<A P> :;LHENM>ER :@K>> PBMA ?KHF HNK HPG >QI>KB>G<> BG LRLM>FL[ >O:EN:MBHG 728:
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

0ABL BL : F>:GBG@?NE =>L<KBIMBHG H? MA> <HG<>IM H? =>@K>>L H? ?K>>=HF :L =>IB<M>= FHK> ?HKF:EER BG CA:IM>K 2. %G MABL <A:IM>K P> PBEE A:O> : EHHD :M : K>:E >Q:FIE> H? LN<A :G HO>K ?BMM>= LRLM>F.

A Bollinger Band system with logic and code


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

115

Trading Systems

Figure 5.3: British pound/US dollar, 30/04/2002-4/7/2008. The Bollinger Band trading system is optimised in six parameters within the training data range (30/04/2002-28/02/2006). Afterwards the results of this trading system are checked in the test data range (1/3/20064/7/2008).

Figure 5.4A: Entry and exit logic of a Bollinger Band breakout system. Four parameters in the entry logic and two parameters in the exit logic can be optimised.

116

The factors around your system

Figure 5.4B: Easy Language Code of a Bollinger Band breakout system with entry and exit logic. Four parameters in the entry logic and two parameters in the exit logic can be optimised.

Entry logic: Bollinger Band system


inputs: LengthUp(18), NumDevsUp(2), LengthDn(20), NumDevsDn(2);

vars: UpperBand(0), LowerBand(0), Price(0);

Price = (O+H+L+C)/4 ; //UpperBand = BollingerBand( Price, LengthUp, NumDevsUp ) ; //LowerBand = BollingerBand( Price, LengthDn, -NumDevsDn ) ; UpperBand = BollingerBandFC( Price, LengthUp, NumDevsUp ) ; LowerBand = BollingerBandFC( Price, LengthDn, -NumDevsDn ) ;

if CurrentBar > 1 and High crosses under UpperBand then Sell Short ( BBandSE ) next bar at UpperBand stop ;

if CurrentBar > 1 and Low crosses over LowerBand then Buy ( BBandLE ) next bar at LowerBand stop ;

Exit Logic:

(for both long positions/short positions) 1) Place an initial stop loss x % below entry price (Opt value: x =1.9) 2) Place a profit target z % above entry price (Opt value: x =4.8)

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Trading Systems

Optimising the Bollinger Band system


%? RHN HIMBFBL> :EE MA>L> LBQ BGINM I:K:F>M>KL MH@>MA>K PBMA :G HIMBFBL:MBHG <KBM>KB: ?H<NL>= HG MA> AB@A>LM G>M IKH?BM HG =:BER =:M: H? MA> IHNG=/=HEE:K "+.!4 F:KD>M BG MA> I>KBH= ?KHF 30/04/2002 MH 28/2/2006 RHN @>M MA> ?HEEHPBG@ K>LNEM ("B@NK> 5.5).
Figure 5.5: Bollinger Band system for British pound/dollar (FOREX), daily, all six input parameters optimised for maximum total net profit, 30/04/2002-28/2/2006. A: Detailed equity curve; B: Underwater equity curve showing all drawdowns.

118

The factors around your system

AL RHN <:G L>> MA> @:BGL H? MA> LRLM>F :K> LM>:=R. 0A> =K:P=HPGL :K> GHM MBGR (:;HNM 10%) ;NM MA> LRLM>F[L IKH?BM:;BEBMR BL AB@A. 0A> MK:=BG@ LRLM>F I>K?HKFL G>:KER :L F:GR LAHKM MK:=>L :L EHG@ MK:=>L :G= LH MA> EHG@/LAHKM ;B:L H? MA> NG=>KERBG@ F:KD>M BL NG=>K <HGMKHE, :EMAHN@A MA> MK:=BG@ LRLM>F A:L AB@A F:KD>M >QIHLNK>, PBMA BM AHE=BG@ : IHLBMBHG BG MA> F:KD>M 89% H? MA> MBF>.

Out-of-sample result
*HP E>M[L L>> PA:M A:II>GL B? RHN :IIER MA> HIMBFBL>= MK:=BG@ EH@B< MH M>LM =:M: HG PAB<A GH HIMBFBL:MBHG A:L M:D>G IE:<>. %G MABL M>LM I>KBH= H? MPH R>:KL ?KHF 1/3/2006 MH 4/7/2008 RHN D>>I MA> L:F> BGINM I:K:F>M>KL :L RHN ?HNG= BG MA> MK:BGBG@ I>KBH= ("B@NK> 5.6).
Figure 5.6: Detailed equity curve of Bollinger Band system for British pound/ dollar (FOREX), daily, training and test period. All six input parameters optimised for maximum total net profit within the training period 30/04/2002-28/02/2006. Test period from 1/3/2006-4/7/2008.

AL RHN <:G L>> MA> LRLM>F A:L <HFIE>M>ER EHLM BML ;KB@AM I>K?HKF:G<>. 0A> LFHHMAER BG<K>:LBG@ >JNBMR <NKO> H? MA> MK:BGBG@ I>KBH= MK:GL?HKF>= BML>E? BGMH : =BK><MBHGE>LL LB=>P:RL FHO>F>GM. 0A> LM>:=R >JNBMR <NKO> H? MA> MK:BGBG@ L>M LN??>KL : ;B@ =K:P=HPG :M MA> ;>@BGGBG@ H? MA> M>LM L>M, ?KHF PAB<A BM G>>=L G>:KER : MPH-R>:K K><HO>KR I>KBH=.

119

Trading Systems

0A>L> H;OBHNL H;L>KO:MBHGL PBMABG MA> >JNBMR EBG> :K> <HG?BKF>= PBMA MA> LRLM>F K>IHKM (0:;E> 5.1). 3A>K>:L PBMABG MA> MK:BGBG@ I>KBH= MA> LRLM>F A:L : MHM:E G>M IKH?BM H? $78,000, BM P:L HGER $379 BG MA> M>LM I>KBH=. "KHF MA> ;B@ :O>K:@> IKH?BM I>K MK:=> H? $1131 BG MA> MK:BGBG@ I>KBH=, HGER $10 BL E>?M BG MA> M>LM I>KBH=. !O>G MA> ;B@@>LM BGMK:=:R =K:P=HPG P:L PHKL> BG MA> LF:EE M>LM I>KBH=: $20,000 BG MA> M>LM I>KBH= <HFI:K>= PBMA $14,000 BG MA> MK:BGBG@ I>KBH=.
Table 5.1: Bollinger Band system for British pound/US dollar (FOREX), daily, training and test period. All six input parameters optimised for maximum total net profit within the training period 30/04/2002-28/2/2006. Test period from 1/3/2006-4/7/2008. TRAIN
Test period from until All Trades Total Net Profit Gross Profit Gross Loss Profit Factor Total Number of Trades Total Number of Long Trades Total Number of ShortTrades Percent Profitable Winning Trades Losing Trades Avg. Trade Net Profit Avg. Winning Trade Avg. Losing Trade Ratio Avg. Win:Avg. Loss Largest Winning Trade Largest Losing Trade Max. Consecutive Winning Trades Max. Consecutive Losing Trades Avg. Bars in Total Trades Avg. Bars in Winning Trades Avg. Bars in Losing Trades Trading Period Percent of Time in the Market Time in the Market Longest Flat Period Max. Equity Run-up Date of Max. Equity Run-up Max. Equity Run-up as % of Initial Capital Max. Drawdown (Intra-day Peak to Valley) Value Date of Max. Drawdown $78,050.50 $150,638.50 ($72,588.00) 2.08 69 30 39 63.77% 44 25 $1,131.17 $3,423.60 ($2,903.52) 1.18 $8,348.00 ($3,658.00) 4 4 13.88 15.52 11 3 Yrs, 11 Mths 89.17% 3 Yrs, 5 Mths, 27 Dys 14 Dys $83,593.50 28/02/2006 83.59% ($14,664.00) 18/05/2004 30/04/2002 28/02/2006 All Trades $379.00 $53,000.00 ($52,621.00) 1.01 36 16 20 47.22% 17 19 $10.53 $3,117.65 ($2,769.53) 1.13 $6,409.00 ($3,884.00) 4 6 15.42 20.71 10.68 2 Yrs, 4 Mths, 8 Dys 85.13% 2 Yrs, 2 Dys 30 Dys $19,428.00 06/12/2007 19.43% ($20,091.00) 10/08/2006

TEST
01/03/2006 04/07/2008

120

The factors around your system

Reasons for the out-of-sample deterioration


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121

Trading Systems

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

5.3 The market data bias

Expanding the training period


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

122

The factors around your system

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
Figure 5.7: British pound/US dollar, 03/03/1986-4/7/2008. The Bollinger Band trading system is now optimised within the long training data range 1986-2006. Afterwards the results of this trading system are checked in the test data range (green). See the shorter training range 2002-2006 which was used above.

123

Trading Systems

Figure 5.8: Bollinger Band system for British pound/US dollar (FOREX), daily, training and test period. All six input parameters are now optimised for maximum total net profit within a longer training period of 20 years: 03/03/1986-28/2/2006. Test period is kept the same, from 1/3/2006-4/7/2008. A: Detailed equity curve; B: Underwater equity curve showing all drawdowns.

124

The factors around your system

Table 5.2: Bollinger Band system for British pound/US dollar (FOREX), daily, training vs. test period. All six input parameters are now optimised for maximum total net profit within a longer training period of 20 years: 03/03/1986-28/2/2006. Test period is kept the same, from 1/3/2006-4/7/2008. TRAIN 03/03/1986 28/02/2006 $175,737.50 $367,121.50 ($191,384.00) 1.92 149 74 75 63.76% 95 52 2 $1,179.45 $3,864.44 ($3,680.46) 1.05 $27,750.00 ($20,050.00) 8 5 34.8 29.67 45.42 5.12% $321.61 $4,363.12 0.09 28.23 0.1 3.3 19 Yrs, 11 Mths, 27 Dys 99.96% 19 Yrs, 11 Mths, 24 Dys n/a $187,179.50 28/02/2006 187.18% TEST 01/03/2006 04/07/2008 $16,757.00 $44,964.00 ($28,207.00) 1.59 28 14 14 64.29% 18 10 0 $598.46 $2,498.00 ($2,820.70) 0.89 $5,578.00 ($8,132.00) 5 3 22.61 22.56 22.7 6.59% $591.59 $2,723.27 0.35 5.86 n/a 2.12 2 Yrs, 4 Mths, 4 Dys 99.42% 2 Yrs, 4 Mths, 1 Dy n/a $29,301.00 16/11/2007 29.30%

Test Period from until Total Net Profit Gross Profit Gross Loss Profit Factor Total Number of Trades Total Number of Long Trades Total Number of Short Trades Percent Profitable Winning Trades Losing Trades Even Trades Avg. Trade Net Profit Avg. Winning Trade Avg. Losing Trade Ratio Avg. Win:Avg. Loss Largest Winning Trade Largest Losing Trade Max. Consecutive Winning Trades Max. Consecutive Losing Trades Avg. Bars in Total Trades Avg. Bars in Winning Trades Avg. Bars in Losing Trades Annual Rate of Return Avg. Monthly Return Std. Deviation of Monthly Return Return Retracement Ratio RINA Index Sharpe Ratio K-Ratio Trading Period Percent of Time in the Market Time in the Market Longest Flat Period Max. Equity Run-up Date of Max. Equity Run-up Max. Equity Run-up as % of Initial Capital Max. Drawdown (Intra-day Peak to Valley) Value Date of Max. Drawdown

($39,750.00) 02/07/1991

($16,939.00) 08/08/2006

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Trading Systems

Conclusion: How to choose your training data


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

5.4 Optimisation and over-fitting

Step-by-step optimisation of the LUXOR system


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

126

The factors around your system

Figure 5.9: Step-by-step optimisation of the six input parameters of the LUXOR system 1. Slow moving average, 2. Fast moving average 3. Time window filter 4. Risk stop loss 5. Trailing stop 6. Profit target. Chart example from British pound/US dollar, 30 minute, FOREX from 26 December 2007.

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

Results depending on the number of optimised parameters


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

127

Trading Systems

HI>K:M>= PBMA : LEHP FHOBG@ :O>K:@> ;:L>= HG 30 ;:KL :G= : ?:LM FHOBG@ :O>K:@> H? 10 ;:KL, GH MBF> ?BEM>K :G= >QBML BG IE:<>) MA> K>LNEM PBMABG MA> M>LM =:M: BL G>@:MBO> ("B@NK> 5.10A). %? RHN GHP HIMBFBL> MA> ?BKLM I:K:F>M>K (LEHP FHOBG@ :O>K:@> L>M MH 40) ?HK MHM:E G>M IKH?BM BG MA> MK:BGBG@ K:G@> MA> LRLM>F K>LNEM BL FN<A BFIKHO>= BG MA> MK:BGBG@ K>@BHG, AHP>O>K MA> >JNBMR <NKO> H? MABL HIMBFBL>= LRLM>F BFIKHO>L HGER LEB@AMER BG MA> M>LM =:M: K:G@> ("B@NK> 5.10B). %? RHN EHHD :M MA> MK:=BG@ ?B@NK>L (0:;E> 5.3) RHN <:G L>> MABL K>LNEM <HG?BKF>=.
Table 5.3: System figures for training and test area after optimisation for total net profit of one parameter after another. The optimised values are different from the gained values in chapter 3 since the optimisation period is shorter now, not the complete data range as before.

Tested symbol:GBPUSD 30 min Parameter number Additional optimised values Total Net Profit Avg. Trade Net Profit Max. Drawdown (Intraday Peak to Valley) 0 1

TRAIN REGION: 21/10/2002-28/2/2007


2 3 4 5 trailing stop: 0.67%, $84,352 $125 6 profit target: 2.25% $90,240 $133

no

time fast window: Risk stop slow moving 9:30a.m.- loss: moving average=40 average=2 1:30 p.m 0.47% GMT $58,018 $51 $58,449 $33 $67,921 $118 $80,827 $127 $12

$17,961

($18,032)

($27,644) ($14,122) ($17,884) ($12,693) ($12,199) ($12,108)

TEST REGION: 1/3/2007-4/7/2008


Parameter number 0 1 2 3 4 5 trailing stop: 0.67%, $25,875 $124 ($9,970) 6 profit target: 2.25% $25,464 $122 ($9,970)

Additional optimised values

no

time window: Risk stop fast slow moving moving 9:30a.m.- loss: average=40 average=2 1:30 p.m 0.47% GMT ($9,736) ($26) ($17,613) $18,038 $34 $37,324 $200 $25,062 $126 ($8,448)

Total Net Profit Avg. Trade Net Profit Max. Drawdown (Intraday Peak to Valley)

($12,569) ($27) ($16,820)

($8,089) ($10,097)

"HK >Q:FIE>, MA> MHM:E G>M IKH?BM PBMABG MA> M>LM =:M: K:G@> BFIKHO>L HGER ?KHF -$12,569 MH -$9,736 :G= MA> :O>K:@> MK:=> ?KHF -$27 MH -$26 :?M>K HIMBFBL:MBHG H? MA> ?BKLM I:K:F>M>K. 0ABL F>:GL IK:<MB<:EER GH <A:G@>. %? RHN HIMBFBL> MA> L><HG= BFIHKM:GM
128

The factors around your system

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BG<K>:L>L PBMA >O>KR :==>= HIMBFBL:MBHG I:K:F>M>K, PA>K>:L MA> I>K?HKF:G<> PBMABG MA> M>LM K:G@> (@K>>G EBG>) <A:G@>L PBMA BG<K>:LBG@ LRLM>F <HFIE>QBMR. 3BMA HGER : ?>P I:K:F>M>KL ;>BG@ HIMBFBL>= MA> G>M IKH?BM BG MA> M>LM K:G@> BG<K>:L>L PBMA >O>KR :==BMBHG:E I:K:F>M>K, K>:<ABG@ BML AB@A PBMA MA> MABK= I:K:F>M>K (MBF> PBG=HP ?BEM>K) :G= MA>G ;>BG@ K>=N<>= PBMA MA> ?HNKMA HIMBFBL>= I:K:F>M>K (KBLD LMHI EHLL). %M MA>G <:GGHM ;> F:=> ;B@@>K :@:BG PBMA ?NKMA>K HIMBFBL>= I:K:F>M>KL.
Figures 5.10 A-G: System LUXOR for British pound/US dollar (FOREX) training and test period. Training period 21/10/2002-28/2/2007 (white), test period 1/3/2007-4/7/2008 (green). One input parameter is optimised after another. A: No optimisation. B: Slow moving average: optimised value = 40. C: Fast moving average: optimised value = 2. D: Time window: optimised setting 9.30am-1.30pm GMT. E: Risk stop loss: optimised setting = 0.47% F: Trailing stop: optimised setting = 0.67%. G: Profit target: optimised setting = 2.25%. The optimised values are different from the gained values in chapter 3 since the optimisation period is shorter now, not the complete data range as before.

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Figure 5.11: Finding an optimal rule complexity for system LUXOR for British pound/US dollar (FOREX) training and test period. The systems input parameters are optimised for maximum total net profit, from left to right, one after another, within the training period 21/10/200228/2/2007 (blue line = training results). Then results are checked in test data range 1/3/2007-4/7/2008 (green line = test results).

The meaning of the trading systems complexity


$HP <:G RHN GHP BGM>KIK>M MABL ;>A:OBHNK H? MA> MK:=BG@ LRLM>F? (>M[L LM:KM PBMABG MA> =B:@K:F ("B@NK> 5.11) ?KHF MA> E>?M LB=> PA>G GH LRLM>F I:K:F>M>K BL HIMBFBL>=. 0A>K> MA> MK:=BG@ LRLM>F A:L : O>KR EHP <HFIE>QBMR, LBG<> MA> :IIEB>= KNE>L :K> JNBM> LBFIE> :G= GHM HIMBFBL>= :M :EE. %? RHN LM:KM MH HIMBFBL> MA> ?BKLM I:K:F>M>K MA> LRLM>F[L I>K?HKF:G<> <A:G@>L F:KD>=ER. 0A> K:P :G= LBFIE> MK:=BG@ EH@B< NL>= LH ?:K <:G >:LBER ;> F:=> ;>MM>K. %GM>K>LMBG@ER PA>G GHM F:GR HIMBFBL>= I:K:F>M>KL A:O> ;>>G BGMKH=N<>= MA> ;>A:OBHNK PBMABG MA> M>LM K:G@> LHF>MBF>L <A:G@>L FHK> MA:G PBMABG MA>

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5.5 Rule complexity explained with polynomial curve fitting

Interpolating data points with polynomial functions


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
Figure 5.12: Ten points of sample data, generated with a sinus function and random distances from it. Curve generated with MATLAB.

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%G HNK <:L> MA> 10 IHBGML P>K> GHM <AHL>G K:G=HFER ;NM PBMA : <HF;BG:MBHG H? : KNE> :G= K:G=HF ;>A:OBHNK. 3> MHHD : LBGNL ?NG<MBHG PAB<A BL : GHKF:E HL<BEE:MBHG :G= IE:<>= MA> 10 IHBGML :KHNG= MA> LBGNL ?NG<MBHG PBMA K:G=HFER M:D>G =BLM:G<>L. $>K> MA>L> :K> CNLM F:MA>F:MB<:E IHBGML ;NM :L : MK:=>K RHN <:G BF:@BG> MA:M MA>L> O:EN>L <HNE= :ELH ;> MA> IKB<>L H? :GR ?BG:G<B:E F:KD>ML, ?HK >Q:FIE> O:EN>L H? : MB<D <A:KM H? MA> "0/! 100 ?NMNK> HK :GR LMH<D RHN EBD>. 0ANL HNK =:M: IHBGM LBFNE:MBHG BL :G :IIKHQBF:MBHG ?HK ?BG:G<B:E F:KD>ML BG MA> P:R MA:M RHN :LLNF> MA:M MA> F:KD>ML A:O> : <>KM:BG HK=>K HK =BK><MBHG (:M E>:LM =NKBG@ LI><B:E MBF>L HK >O>GML) ;NM MA:M :KHNG= MABL HK=>K RHN A:O> EHML H? K:G=HF ;>A:OBHNK :G= F:KD>M GHBL>. 0H BGM>KIHE:M> MA>L> 10 =:M: IHBGML :L P>EE :L IHLLB;E> RHN <:G NL> F:MA>F:MB< IHERGHFB:E ?NG<MBHGL PBMA =B??>K>GM <HFIE>QBMR. 0A> AB@A>K MA> HK=>K H? MA> IHERGHF, MA> @K>:M>K BML <HFIE>QBMR ;><HF>L. 0A> >:LB>LM IHERGHFB:E ?NG<MBHG (=>@K>> = 0) BL : <HGLM:GM ("B@NK> 5.13).
Figure 5.13: Approximation of the ten data points with a polynomial function of degree = 0, a constant with value = 0. Curve generated with MATLAB.

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

Figure 5.14: Approximation of the ten data points with a polynomial function of degree = 1, a linear function. Curve generated with MATLAB.

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Figure 5.15: Approximation of the ten data points with a polynomial function of degree = 2, a parabolic function. Curve generated with MATLAB.

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Figure 5.16: Approximation of the ten data points with a polynomial function of degree = 3. The fitness to the data points increases but also the complexity of the function. Curve generated with MATLAB.

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Figure 5.17: Approximation of the ten data points with a complex polynomial function of degree = 9. Curve generated with MATLAB.

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5HN <:G :ELH IEHM MA> K>LNEML H? MA>L> @K:IAL BG : M:;E> (0:;E> 5.4). 0A>K> RHN L>> AHP MA> :O>K:@> >KKHK H? MA> ?BMG>LL ?NG<MBHG ;><HF>L LF:EE>K PBMA : AB@A>K =>@K>> H? IHERGHFB:E. 3A>K>:L MA> IHERGHFB:E H? =>@K>> 0 A:L : ;B@ LM:G=:K= =>OB:MBHG ?KHF MA> 10 =:M: IHBGML (5.39), MA> 9MA =>@K>> IHERGHFB:E G>:KER K>:<A>L MA> IHBGML PBMAHNM :GR >KKHK (0.0003).
Table 5.4: Average error of fit to data points (standard deviation) as a function of the degree of the polynomial. The higher the degree of the polynomial, the better its fit to the data points, but the higher its rule complexity becomes.

Degree of Polynomial 0 1 2 3 4 5 6 7 8 9

Average error of fit to data points (standard deviation) 5.3932 2.1863 1.6583 0.057 0.0555 0.046 0.0407 0.0407 0.0256 0.0003

%? RHN A:O> : <EHL>K EHHD :M MA> K>LNEM H? MA> 9MA =>@K>> IHERGHFB:E ?BM RHN <:G L>> MA:M MA> ?BMM>= <NKO> HL<BEE:M>L PBE=ER :G= @BO>L HGER : O>KR IHHK K>IK>L>GM:MBHG H? MA> <AHL>G LBGNL-?NG<MBHG PBMA MA> =:M: IHBGML K:G=HFER :KHNG= BM. 0ABL 9MA =>@K>> IHERGHFB:E <HNE= LM:G= ?HK : O>KR <HFIE>Q MK:=BG@ LRLM>F PBMA F:GR <HFIHG>GML :==>= NGMBE RHN A:O> @HM : I>K?><M ?BM H? MA> MK:=BG@ EH@B< MH RHNK F:KD>M =:M:.

BNM PA:M :K> MA> <HG<ENLBHGL PAB<A RHN <:G =K:P ?KHF MA>L> ?BMG>LL ?NG<MBHGL :G= PA:M BL MA> IK>=B<MBO> IHP>K H? MA> =B??>K>GM IHERGHFB:EL ?HK MA> ?NMNK>?

Predictive power of the different polynomials


(>M[L L>> PA:M A:II>GL B? P> :== ?NKMA>K =:M: IHBGML ;R E>MMBG@ MA> LBGNL ?NG<MBHG <HGMBGN> BGMH MA> ?NMNK> ("B@NK> 5.18). 5HN <:G L>> MA:M MA> IHERGHFB:E H? =>@K>> 0 <HGMBGN>L MH @H LB=>P:RL PBMA MA> LBGNL ?NG<MBHG. 0ANL MA> IK>=B<MBO> IHP>K H? MABL O>KR LBFIE> ?NG<MBHG ?HK MA> ?NMNK> BL JNBM> IHHK, ;NM BM BL PHKMA F>GMBHGBG@ MA:M BM LM:RL >Q:<MER MA> L:F> :L MA> K>LNEM H? MA> ;:<D-M>LM H? MA> M>G =:M: IHBGML.

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Figure 5.18: Predictive capability of the polynomial of degree =0 for unseen test data. Curve generated with MATLAB.

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Figure 5.19: Predictive capability of the polynomial of degree = 9 for unseen test data. Curve generated with MATLAB.

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Conclusions for trading system development


3A:M RHN A:O> L>>G BG MABL >Q:FIE> BL CNLM MA:M F:KD>ML <:GGHM ;> :IIKH:<A>= PBMA INK> F:MA>F:MB<:E F>MAH=L. BNM MABL =H>L GHM F>:G MA:M :EE MK:=BG@ LRLM>FL FNLM ;> H? S>KH<HFIE>QBMR. +NK FBLM:D> A>K> P:L MA:M P> MKB>= MH :IIKH:<A : I>KBH=B< LBGNL ?NG<MBHG PBMA : GHG-I>KBH=B< IHERGHFB:E ?NG<MBHG. (BD> MABL P> ?HK<>= HNK :E@HKBMAF MH :=:IM MH : LBMN:MBHG ?HK PAB<A BM BL GHM ;NBEM. 0A> IHERGHFB:E ?NG<MBHG P:L GHM LNBM>= MH MA> ?NG<MBHG P> P>K> MKRBG@ MH NL> BM ?HK ;><:NL> BM BL GHM MA> <HKK><M :IIKHQBF:MBHG ?HK : I>KBH=B< >GOBKHGF>GM. 0A> B=>: H? I>KBH=B<BMR P:L FBLLBG@. 0A> <HG<ENLBHG ?HK RHN :L : LRLM>F =>O>EHI>K :G= MK:=>K BL MA:M RHN FNLM ?BKLM A:O> :G B=>: H? MA> F:KD>M! +GER PA>G RHN A:O> MABL <:G RHN LM:KM MH <H=> RHNK B=>: :G= HGER EBD> MABL PBEE RHN @>M : <H=> MA:M F:D>L L>GL>. &NLM :L BM BL NL>E>LL MH :IIKH:<A I>KBH=B< ?NG<MBHGL PBMA IHERGHFB:EL, BM BL NL>E>LL MH :IIKH:<A MK>G=E>LL F:KD>ML PBMA MK>G=-?HEEHPBG@ F>MAH=L HK MH :IIKH:<A F:KD>ML PBMA GH OHE:MBEBMR PBMA ;K>:D-HNM LRLM>FL. 3> DGHP MA:M MABL E>:=L BGMH ?NKMA>K <HG?EB<ML LBG<> F:KD>ML :K> LM>:=BER <A:G@BG@, ;NM NLBG@ B=>:L :G= >QI>KB>G<> BL MA> ;>LM :IIKH:<A RHN <:G M:D>. "NKMA>K <HGL>JN>G<>L H? MA>L> M>LML :K> MA:M HG<> RHN A:O> : LBFIE>, KH;NLM EH@B< PBMA : IKHI>K KBLD F:G:@>F>GM BG IE:<> RHN <:G LMHI RHNK LRLM>F =>O>EHIF>GM IKH<>LL. %M BL H?M>G ;>MM>K MH NL> CNLM HG> HK MPH BG=B<:MHKL, HK HGER MA> IKB<> BML>E?, K:MA>K MA:G L>O>K:E <HF;BG>= BG=B<:MHKL. A==BG@ FHK> :G= FHK> KNE>L PBEE CNLM BG<K>:L> MA> :=:IM:MBHG H? RHNK MK:=BG@ LRLM>F MH I:LM F:KD>M =:M:, ;NM BM PBEE GHM BG<K>:L> BML IK>=B<MBO> IHP>K ?HK K>:E MK:=BG@. 0A>K>?HK> BM BL ;>MM>K MH L:O> RHNK MBF> :G= BGO>LM BM HMA>KPBL>, ?HK >Q:FIE> BG :==BG@ : FHG>R F:G:@>F>GM L<A>F> HK ;R =BO>KLB?RBG@ RHNK LMK:M>@R PBMA ?NKMA>K LBFIE> ;NM KH;NLM LRLM>FL PBMABG : IHKM?HEBH.

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Periodic re-optimisation and walk forward analysis
6.1 Short repetition: normal, static optimisation
(>M[L ?BKLM K>FBG= HNKL>EO>L H? MA> XGHKF:EY HIMBFBL:MBHG IKH<>LL PAB<A P> L>M HNM BG CA:IM>K 5. %G HK=>K MH HIMBFBL> RHNK LRLM>F RHN M:D> : ?BQ>= MK:BGBG@ =:M: L>M (XBG L:FIE> =:M:Y) :G= MA>G RHN :IIER MA> LRLM>F MH IK>OBHNLER NGL>>G =:M:: MABL BL MA> LH <:EE>= XM>LM L>MY HK XHNM-H?-L:FIE> =:M:Y ("B@NK> 6.1). %G HNK >Q:FIE> MA> MK:BGBG@ =:M: L>M P:L :;HNM ?HNK R>:KL :G= ?HNK FHGMAL, ?KHF 21/10/2002 MH 28/2/2007 :G= MA> M>LM L>M P:L HG> R>:K :G= ?HNK FHGMAL ?KHF 1/3/2007 MH 4/7/2008.

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Figure 6.1: Equity curve of system LUXOR for British pound/US dollar (FOREX) training and test period, 30 minute data. Training period 21/10/2002-28/2/2007 (white), test period 1/3/2007-4/7/2008 (green).

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

148

Periodic re-optimisation and walk forward analysis

6.2 Anchored vs. rolling walk forward analysis (WFA)


%? RHN M:D> MA> :;HO> >Q:FIE> ;NM F:D> MA> HIMBFBL:MBHG PBG=HP ;B@@>K :G= ;B@@>K RHN :KKBO> :M :G :G<AHK>= 3"A. 0A> HIMBFBL:MBHG BL :G<AHK>= LBG<> BM :EP:RL LM:KML :M MA> L:F> IHBGM H? MBF> ("B@NK> 6.2A). 0ABL BL MA> LBFIE>LM ?HKF H? 3"A. %M NLN:EER PHKDL ;>LM, EBD> MA> LM:MB< HIMBFBL:MBHG P> >Q:FBG>= :;HO>, PA>G MA> M>LM>= F:KD>M D>>IL BML I>KLHG:EBMR PBMABG MA> M>LM>= L:FIE>.
Figure 6.2A: Anchored walk forward analysis. For every new optimisation run the in-sample optimisation window starts at the same point of time but its length is subsequently increased. The unseen out-of-sample data follows.

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Figure 6.2B: Rolling walk forward analysis. Shifting in-sample optimisation window = 1 year and shifting unseen out-of-sample data = the 3 following months.

0A> ;>MM>K :=:IM:MBHG H? MA> KHEEBG@ 3"A F:R F>:G BM BL FHK> :IIKHIKB:M>, :G= F:R RB>E= K>LNEML MA:M P:ED ?HKP:K= ;>MM>K, BG EBO> MK:=BG@ MA:G K>LNEML H;M:BG>= ?KHF :G :G<AHK>= 3"A.

6.3 Rolling WFA on the LUXOR system

Periodic optimisation of the two main system parameters


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Periodic re-optimisation and walk forward analysis

3BMA MA> KHEEBG@ 3"A P> A:O> : MK:BGBG@ L>M PAB<A BL GHM LM:MB< :L ;>?HK> ;NM PAB<A BL FHOBG@ ?HKP:K= :L MA> MBF> @H>L ;R. %G HNK <:L> P> NL> HG>-R>:K BG-L:FIE> HIMBFBL:MBHG I>KBH=L PAB<A FHO> ?HKP:K= >O>KR MAK>> FHGMAL. 3BMA >:<A G>P HIMBFBL:MBHG RHN @>M MPH G>P HIMBF:E FHOBG@ :O>K:@> O:EN>L. "HK >Q:FIE>, =NKBG@ MA> HIMBFBL:MBHG I>KBH= ;>MP>>G *HO>F;>K 2002 :G= *HO>F;>K 2003 RHN @>M :G HIMBF:E ?:LM FHOBG@ :O>K:@> E>G@MA H? 3 ;:KL :G= :G HIMBF:E LEHP FHOBG@ :O>K:@> E>G@MA H? 21 ;:KL. %? RHN LAB?M MA> HIMBFBL:MBHG I>KBH= ;R 3 FHGMAL MH ">;KN:KR 2003 NGMBE ">;KN:KR 2004 MA> I:K:F>M>K[L ;>LM O:EN>L <A:G@> MH 1 (?:LM) :G= 39 (LEHP) ?HK MA> FHOBG@ :O>K:@>L. (+? <HNKL> : XFHOBG@ :O>K:@>Y H? E>G@MA 1 BL CNLM MA> IKB<> BML>E?.) %? RHN LAB?M MA> HIMBFBL:MBHG PBG=HP ;R 3 FHGMAL :@:BG (GHP ?KHF ):R 2003 NGMBE ):R 2004) MA> MPH BGINM I:K:F>M>KL <A:G@> :@:BG MH 1 (?:LM) :G= 21 (LEHP) PAB<A BL LAHPG BG (0:;E> 6.1). /H BGLM>:= H? MA> LM:MB< HIMBFBL:MBHG RHN GHP A:O> 19 HIMBFBL:MBHG KNGL ?HK MA> MPH F:BG BGINM I:K:F>M>KL PBMABG MA> MK:BGBG@ I>KBH=. ,E>:L> GHM> MA:M MA>L> 19 HIMBFBL:MBHG KNGL NL> G>:KER MA> PAHE> F:KD>M =:M: K:G@> ?HK ;HMA HIMBFBL:MBHG :G= ?HK M>LMBG@. .>F>F;>K MA:M MA> LM:MB< HIMBFBL:MBHG ?KHF CA:IM>K 5.4 CNLM <HNE= NL> : LF:EE I:KM H? :;HNM HG> R>:K H? MA> =:M: ?HK MA> HNM-H?-L:FIE> M>LM. /H RHN GHP @>M : FN<A FHK> =>M:BE>= M>LM H? RHNK MK:=BG@ LRLM>F HG FN<A FHK> =:M: W GHM ;R A:OBG@ FHK> =:M: :O:BE:;E> (RHN LMBEE HGER A:O> MA> 6 R>:KL ?KHF 2002 MH 2008) ;NM ;R NLBG@ BM BG : <E>O>K>K P:R.

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Table 6.1: Periodic re-optimisation of the trading system LUXOR on 30 minute data of the GBP/USD FOREX pair. The gained best parameters are applied subsequently to out-ofsample areas of 3-month test data.

Training Set
Training Start 1-Nov-02 1-Feb-03 1-May-03 1-Aug-03 1-Nov-03 1-Feb-04 1-May-04 1-Aug-04 1-Nov-04 1-Feb-05 1-May-05 1-Aug-05 1-Nov-05 1-Feb-06 1-May-06 1-Aug-06 1-Nov-06 1-Feb-07 1-May-07 Training End 1-Nov-03 1-Feb-04 1-May-04 1-Aug-04 1-Nov-04 1-Feb-05 1-May-05 1-Aug-05 1-Nov-05 1-Feb-06 1-May-06 1-Aug-06 1-Nov-06 1-Feb-07 1-May-07 1-Aug-07 1-Nov-08 1-Feb-08 1-May-08 Fast Moving Average 3 1 1 1 1 1 2 1 1 1 1 5 2 1 1 6 1 1 1 Slow Moving Average 21 39 21 21 27 27 33 15 15 15 15 48 39 39 39 21 24 24 24

Test Set
Test Start 1-Nov-03 1-Feb-04 1-May-04 1-Aug-04 1-Nov-04 1-Feb-05 1-May-05 1-Aug-05 1-Nov-05 1-Feb-06 1-May-06 1-Aug-06 1-Nov-06 1-Feb-07 1-May-07 1-Aug-07 1-Nov-08 1-Feb-08 1-May-08 Test End 1-Feb-04 1-May-04 1-Aug-04 1-Nov-04 1-Feb-05 1-May-05 1-Aug-05 1-Nov-05 1-Feb-06 1-May-06 1-Aug-06 1-Nov-06 1-Feb-07 1-May-07 1-Aug-07 1-Nov-08 1-Feb-08 1-May-08 1-Aug-08

152

Periodic re-optimisation and walk forward analysis

%? RHN IEHM MA> MPH HIMBFBL>= BGINM I:K:F>M>KL :L : ?NG<MBHG H? MA> LM:KM H? MA> HIMBFBL:MBHG PBG=HP RHN L>> MA>BK <A:G@> PBMABG MA> ?BO> R>:KL ("B@NK> 6.3). ,E>:L> GHM> MA:M MA> MPH HIMBFBL>= I:K:F>M>KL <A:G@> K:MA>K LEHPER W :G BFIHKM:GM :LI><M ?HK MA> @:BG>= HNM-H?L:FIE> M>LM K>LNEML, PAB<A P> PBEE =BL<NLL GHP.
Figure 6.3: Change of the optimal parameters for the fast and slow moving averages as a function of the shifting one year optimisation period. During the tests the following other parameters are kept in place: entry time window 9.30am-1.30pm GMT, exits: 0.3% risk stop, 0.8% trailing stop and 1.9% optimised for trading system LUXOR on 30 minute data of the GBP/USD FOREX pair.

Out-of-sample test result


(>M[L :IIER MA> MK:=BG@ LRLM>F PBMA MA>L> HIMBFBL>= I:K:F>M>KL MH MA> NGL>>G =:M:. %G 0:;E> 6.1 RHN <:G L>> MA:M MA> HIMBF:E I:K:F>M>KL 3 (?:LM) :G= 21 (LEHP) PAB<A A:O> ;>>G @:BG>= BG MA> ?BKLM HG>-R>:K HIMBFBL:MBHG PBG=HP ;>MP>>G 1 *HO>F;>K 2002 :G= 1 *HO>F;>K 2003 :K> :IIEB>= MH MA> LN;L>JN>GM MAK>> FHGMAL ?KHF 1 *HO>F;>K 2003 NGMBE 1 ">;KN:KR 2004 H? NGL>>G =:M:. 0A> HIMBF:E I:K:F>M>KL ?HK MA> LN;L>JN>GM HIMBFBL:MBHG I>KBH= (">;KN:KR 2003 NGMBE ">;KN:KR 2004: ?:LM FHOBG@ :O>K:@> = 1 ;:K, LEHP FHOBG@ :O>K:@> = 39 ;:KL) :K> :IIEB>= MH MA> NGL>>G =:M: ;>MP>>G 1 ">;KN:KR 2004 :G= 1 ):R

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2004 :G= LH ?HKMA ?HK :EE MA> HMA>K 17 I>KBH=L. %G MABL P:R RHN @>M : <HFIE>M> HNM-H?L:FIE> M>LM H? MA> MK:=BG@ LRLM>F :IIEB>= MH IK>OBHNLER NGL>>G =:M:. 0A> K>LNEM BL LAHPG BG "B@NK> 6.4.
Figure 6.4: Out-of-sample test for the periodically optimised values. System LUXOR for British pound/US dollar (FOREX) 2/11/2003-4/7/2008. During the tests the following other parameters are kept in place: entry time window 9.30am-130pm GMT, exits: 0.3% risk stop, 0.8% trailing stop and 1.9% optimised for trading system LUXOR on 30 minute data of the GBP/USD FOREX pair.

Equity curve detailed GBPUSD 30 min(11/02/03 23:30 07/02/08 23:59)

Equity ($)

11/4/2003 4:00:00 PM 7/2/2008 10:59:00 PM

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

154

Periodic re-optimisation and walk forward analysis

Conclusion
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

6.4 The meaning of sample size and market structure


+G> IHBGM PAB<A BL K>E>O:GM =NKBG@ >O>KR HIMBFBL:MBHG IKH<>LL :G= >LI><B:EER H? I>KBH=B< K>-HIMBFBL:MBHG BL MA> JN>LMBHG H? AHP MH <AHHL> RHNK HIMBFBL:MBHG I>KBH=. H RHN K>HIMBFBL> >O>KR =:R, >O>KR MPH P>>DL HK >O>KR R>:K? 5HNK <HFINM>K, PBMA BML EBFBM>= IHP>K, F:R @BO> :G :GLP>K MH MABL JN>LMBHG ;NM MA>K> :K> LMBEE HMA>K IHBGML MA>K> MH BGO>LMB@:M>, HG> H? PAB<A BL MA> F:KD>M[L BGA>K>GM :MMKB;NM>L, PAB<A P> <:EE XF:KD>M LMKN<MNK>Y. %G HNK (14+. LRLM>F P> A:= : KHEEBG@ HIMBFBL:MBHG I>KBH= H? HG> R>:K :G= : LN;L>JN>GM HNM-H?-L:FIE> M>LM I>KBH= H? MAK>> FHGMAL. 0A>L> <AHL>G L>MMBG@L IKHO>= MH ;> :IIKHIKB:M> ?HK HNK LRLM>F/F:KD>M <HF;BG:MBHG. BNM PA:M :K> @HH= L>MMBG@L ?HK HMA>K LRLM>FL :G= F:KD>ML? 3A:M B? RHN PHKD PBMA =:BER =:M:, PBMA 10 FBGNM> =:M: HK PBMA 1 FBGNM> =:M:?

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Trading Systems

+G : 0K:=>/M:MBHG ?HKNF P> K><>GMER ?HNG= : =HN;E>->=@>= <HFF>GM :;HNM MABL MHIB<:
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
Figure 6.5: The market changes as a function of the time. Every market has its special structure, frequency, trends etc.

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Periodic re-optimisation and walk forward analysis

Figure 6.6: Optimisation window fits to the market structure. Ideal case: unseen data is same as data in optimisation window.

Figure 6.7: Data in the optimisation window has a different structure than the unseen data. Worst case optimisation window.

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

157

Trading Systems

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

158

7
Position sizing example, using the LUXOR system
/M>:=R FHG>R BL GHM F:=> ;R FRLM>KBHNL LNI>K MK:=BG@ LRLM>FL, BM BL F:=> ;R IKHI>K FHG>R F:G:@>F>GM H? :O>K:@> MK:=BG@ LRLM>FL.

7.1 Definitions: money management vs. risk management


%G HK=>K MH NG=>KLM:G= PA:M FHG>R F:G:@>F>GM K>:EER F>:GL, BML K>E:MBHG MHP:K=L KBLD F:G:@>F>GM BL >LL>GMB:E. 0ANL P> ?BKLM H? :EE P:GM MH PHKD HNM MA> =B??>K>GM F>:GBG@L H? MA> MPH M>KFL.

Risk management (RM)


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

159

Trading Systems

Money management (MM)


%G LBFIE>K PHK=L )) BL <:EE>= XIHLBMBHG LBSBG@Y. %M =>L<KB;>L AHP MH NL> RHNK >QBLMBG@ MK:=BG@ <:IBM:E BG MA> FHLM >??B<B>GM P:R :G= BM IKHOB=>L :GLP>KL MH MA> ?HEEHPBG@ ;:LB< JN>LMBHGL: 1. 2. 3. 3A:M I>K<>GM:@> H? MA> :O:BE:;E> ?NG=L LAHNE= ;> MHM:EER BGO>LM>=? 3A:M I>K<>GM:@> H? MA> :O:BE:;E> ?NG=L BL BM IHLLB;E> MH KBLD BG MA> G>QM MK:=> BG : LI><B:E F:KD>M? 3A:M E>O>K:@> :G= F:KD>M >QIHLNK> LAHNE= ;> <AHL>G?

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

160

Position sizing example, using the LUXOR system

Figure 7.1: The interaction of money and risk management. The goal of money management is to maximise your profits. The goal of risk management is to minimise your risks. The two different processes are connected with each other.

Distribution of trading capital on positions/contracts Diversification

Minimising Risks control with exits and trading logic

Maximising Profits control with contract number

0A> =BLM:G<> H? RHNK BGBMB:E LMHIL :G= MA>K>?HK> MA> KBLD H? RHNK MK:=BG@ LRLM>F BL BFIHKM:GM ?HK MA> =>M>KFBG:MBHG H? MA> GNF;>K H? EHML RHN <:G MK:=>. +G MA> HMA>K A:G= MA> =BLMKB;NMBHG H? RHNK MK:=BG@ <:IBM:E BL BFIHKM:GM BG =><B=BG@ AHP FN<A RHN <:G KBLD BG : LBG@E> MK:=> BG : LBG@E> F:KD>M.

7.2 Application of different MM schemes


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

=
161

Trading Systems

Reference: The system traded with one lot


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
Figure 7.2: Detailed equity curve. Traded with one fixed lot. Starting account size = $100,000. LUXOR system British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time filter and exits in place. Including $30 S+C per RT. An area with a recent small drawdown is encircled as a comparison for the following MM schemes. Chart created with Market System Analyzer.

162

Position sizing example, using the LUXOR system

Maximum drawdown MM
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
Figure 7.3: 150% maximum drawdown MM by Larry Williams. Upper blue line: equity curve. Lower black area: number of traded lots. Starting account size = $100,000. Trend-following system British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time filter and exits in place. Including $30 S+C per RT. An area with a recent drawdown is encircled. Chart created with Market System Analyzer.

163

Trading Systems

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

Fixed fractional MM
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

164

Position sizing example, using the LUXOR system

0A>K> BL : IHLLB;BEBMR MA:M HIMBHG 1 =BK><MER :??><ML MA> MK:=BG@ EH@B<. "KHF :EE HNK ?BG=BG@L :;HNM LMHIL :G= IKH?BM M:K@>ML P> DGHP MA:M MA> MK:=BG@ LRLM>F I>K?HKF:G<> LN??>KL PBMA LMHIL MA:M :K> MHH MB@AM. "KHF MA> =BL<NLLBHG BG CA:IM>K 3 RHN A:O> L>>G MA:M MK:=>L G>>= >GHN@A KHHF MH =>O>EHI. 0B@AM LMHIL K>FHO> MABL KHHF :G= <:G MNKG : IKH?BM:;E> LMK:M>@R BGMH : EHLBG@ LMK:M>@R. /BG<> P> =H GHM P:GM MH <A:G@> MABL KBLD F:G:@>F>GM BM F>:GL P> FNLM <A:G@> HNK FHG>R F:G:@>F>GM (IHLLB;BEBMR 2) :G= L>M MA> BGBMB:E :<<HNGM O:EN> AB@A>K. HBG@ MABL BL FN<A >:LB>K MH <:E<NE:M> ;NM F>:GL BG IK:<MB<> MA:M RHN FNLM A:O> >GHN@A ?NG=L :O:BE:;E>. 0A:M[L HG> K>:LHG PAR LBG@E> MK:=>KL O>KR L>E=HF NL> )) L<A>F>L :G= PAR ;B@@>K ?NG=L :K> FHK> LN<<>LL?NE BG MA> EHG@ KNG. (>M[L <:E<NE:M> AHP FN<A LAHNE= ;> MA> FBGBFNF :<<HNGM. 3> P:GM MH KBLD 2% H? HNK :<<HNGM PBMA MA> G>QM MK:GL:<MBHG. /BG<> HNK KBLD PBMA HG> EHM BL <AHL>G ;R MA> IK>L>M LMHI EHLL H? MA> MK:=BG@ LRLM>F ($600), MABL F>:GL MA:M MA> :<<HNGM FNLM ;> :M E>:LM $30,000, PA>G MK:=BG@ HG> EHM :M MABL KBLD ($600 BL 2% H? $30,000). 3> M:D> =HN;E> MABL O:EN> MH ;> LNK> GHM MH <HG?EB<M PBMA HNK KBLD L>MMBG@L. /H P> MK:=> HG> EHM PBMA $60,000. 3BMA : LM:KMBG@ :<<HNGM O:EN> H? $100,000 MABL F>:GL MA:M HG> EHM BL :EEHP>= I>K MK:GL:<MBHG NGMBE MA> :<<HNGM O:EN> A:L K>:<A>= $120,000 (= 2 Q $60,000). 0A> MABK= EHM <:G ;> MK:=>= PA>G MA> :<<HNGM K>:<A>L $180,000 :G= LH HG. ,E>:L> GHM> MA:M PA>G MA> :<<HNGM >JNBMR =><K>:L>L, MA> GNF;>K H? MK:=>= EHML :ELH A:L MH ;> EHP>K>= :<<HK=BG@ER. 0A> K>LNEM H? MABL )) BL LAHPG BG "B@NK> 7.4A. 5HN L>> MA:M PABE> MA> >JNBMR <NKO> (;EN> EBG>) BL @KHPBG@, FHK> EHML <:G ;> :==>= (EHP>K ;E:<D :K>:), NGMBE MA> AB@A>LM :<<HNGM O:EN> H? $790,000, K>:<A>= BG ):R 2008, PA>G 14 EHML :K> MK:=>=. 3A>G MK:=BG@ PBMA LH F:GR EHML MA> MK:=BG@ LRLM>F <HF>L BGMH : =K:P=HPG IA:L> (K>= >G<BK<E>=) PAB<A MA>G E>:=L MH : ;B@@>K =K:P=HPG. ,E>:L> GHM> AHP MABL =K:P=HPG IA:L> BL AN@> <HFI:K>= PBMA MA> HKB@BG:E MK:=BG@ LRLM>F MK:=>= PBMA HG> ?BQ>= EHM LBG<> GHP MA> =K:P=HPG BL :FIEB?B>= ;R MA> 14 EHML. %M BL PHKMA ?BG=BG@ HNM PA:M A:II>GL PA>G P> BG<K>:L> MA> KBLD I>K MK:GL:<MBHG FHK> :G= FHK>, MH 5%, 10% MA>G >O>G MH 30% ("B@NK>L 7.4B- ). AL RHN <:G L>> MA> ;B@@>LM >JNBMR IHBGM K>:<A>= BG ):R 2008 @>ML =K:F:MB<:EER AB@A>K :G= AB@A>K. 3A>K>:L MA> ?BQ>= ?K:<MBHG:E )) PBMA 2% KBLD K>:<A>L : ;B@@>LM >JNBMR I>:D H? $790,000, MA> )) PBMA 5% KBLD K>:<A>L HO>K $22 FBEEBHG, MA> )) PBMA 10% K>:<A>L $981 FBEEBHG :G= MA> )) PBMA 30% KBLD K>:<A>L HO>K $6 ;BEEBHG! BNM :L RHN DGHP, XMK>>L =H GHM @KHP MH MA> LDRY :G= MA> AB@A IKH?BML A:O> : AB@A IKB<>. 3BMA MA> 30% ?BQ>= ?K:<MBHG:E )) ?BG:EER XHGERY $538 FBEEBHG BL E>?M ?KHF MA> $6 ;BEEBHG K>:<A>= ;>?HK>. /H MA> LN??>K>= =K:P=HPG ?KHF MA> >JNBMR I>:D H? HO>K $6 ;BEEBHG P:L M>G MBF>L AB@A>K MA:G MA> ?BG:E IKH?BM! 0A> FHK> :@@K>LLBO> MA> )) MA:M BL <AHL>G, MA>

165

Trading Systems

AB@A>K MA> >JNBMR I>:D, ;NM MA> ;B@@>K MA> =K:P=HPG PAB<A MA> >JNBMR <NKO> LN??>KL MA>K>:?M>K. 0A> ?BQ>= ?K:<MBHG:E )) L<A>F> PHKDL EBD> :G :FIEB?B>K H? MA> @:BGL ;NM :ELH H? MA> EHLL>L. 5HN L>> :@:BG ?KHF MABL LBFIE> >Q:FIE>, :L PBMA MA> :;HO> LAHPG F:QBFNF =K:P=HPG )), MA:M :EMAHN@A :G :@@K>LLBO> )) L>>FL MH ;> :MMK:<MBO> :M MA> ?BKLM @E:G<> ;><:NL> BM IKHFBL>L ;B@ IKH?BML, MA> KBLDL ;>ABG= BM JNB<DER ;><HF> MHH AB@A.
Figure 7.4: Applying fixed fractional MM. The aggressiveness of the MM is increased from 2%, 5%, 10% up to 30%. Upper blue line: equity curve. Lower black area: number of traded lots. Starting account size = $100,000. Trend-following system British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time filter and exits in place. Including $30 S+C per RT. An area with a recent drawdown is encircled. Charts created with Market System Analyzer.

166

Position sizing example, using the LUXOR system

167

Trading Systems

D
/H E>M[L L>> B? MA>K> :K> FHK> <HGL>KO:MBO> F>MAH=L HNM MA>K>.

Fixed ratio MM
"BQ>= K:MBH )) P:L ?BKLM BGMKH=N<>= ;R .R:G &HG>L BG ABL ;HHD The T&adi#g Ga"e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
N = 0.5 * [((2 * N0 * 1)2 + 8 * P/del&a)0.5 + 1]

168

Position sizing example, using the LUXOR system

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

169

Trading Systems

Figure 7.5: Fixed Ratio vs. Fixed Fractional MM. As trading capital increases, the fixed ratio MM increases the number of lots more slowly, with a square root function, than the fixed fractional MM, which works linearly.

0H L>> AHP ?BQ>= K:MBH )) PHKDL E>M[L LM:KM PBMA : =>EM: H? $100,000. 0ABL F>:GL MA:M RHN <:G :== MA> L><HG= EHM HGER :?M>K RHNK :<<HNGM O:EN> A:L BG<K>:L>= ;R :GHMA>K $100,000 MH $200,000 ("B@NK> 7.6A). +;OBHNLER MABL )) BL O>KR LEHP :G= GHM FN<A =B??>K>GM ?KHF CNLM MK:=BG@ HG> EHM :EE MA> MBF> LH E>M[L F:D> BM : ;BM FHK> :@@K>LLBO>. ("B@NK>L 7.6B :G= C).

170

Position sizing example, using the LUXOR system

Figure 7.6: Applying fixed ratio MM. The aggressiveness of the MM is increased from A to C. Upper blue line: equity curve. Lower black area: number of traded lots. Starting account size = $100,000. LUXOR system on British pound/US dollar (FOREX), 30 minute bars, 21/10/20024/7/2008, with entry time filter and exits in place. Including $30 S+C per RT. An area with a recent drawdown is encircled. Chart created with Market System Analyzer.

171

Trading Systems

172

Position sizing example, using the LUXOR system

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

7.3 Monte Carlo analysis of the position sized system


,HLBMBHG LBSBG@ BG<K>:L>L RHNK IKH?BML. BNM PBMA MA> IKH?BML MA> KBLDL :ELH ;><HF> AB@A>K. 0H @>M : ;>MM>K B=>: H? AHP ;B@ MA> KBLDL ;><HF> P> =H : )HGM> C:KEH :G:ERLBL H? MA> (14+. LRLM>F :?M>K IHLBMBHG LBSBG@ :G= <HFI:K> BML K>LNEML PBMA MA> LBMN:MBHG PA>G GH )) BL :IIEB>= (0:;E> 7.1).

173

Trading Systems

Table. 7.1: System figures without (green) and with money management (yellow). LUXOR system on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008, with entry time filter and exits in place. Including $30 S+C per RT.

One Fixed Contract Test period: Market Costs: Number of samples for Monte Carlo Analysis Minimum Number of Contracts Average Number of Contracts Total Net Profit Starting Account value Final Account Equity Total Number of Trades Number of Winning Trades Number of Losing Trades Largest Winning Trade Average Winning Trade Largest Losing Trade Average Losing Trade Monte Carlo Analysis Results ORIGINAL SYSTEM MONTE CARLO RESULTS AT 90% CONFIDENCE MONTE CARLO RESULTS AT 95% CONFIDENCE MONTE CARLO RESULTS AT 99% CONFIDENCE 21/10/2002-4/7/2008 GBP/USD, 30 min bars 30$ Slipp. + Comm. 5000

$5000 Fixed Ratio MM 21/10/2002-4/7/2008 GBP/USD, 30 min bars 30$ Slipp. + Comm. 5000 27 1 12 $1,528,499 $50,000 $1,578,499 1,051 370 681 $90,144 $13,737 ($15,418) ($4,860) Worst Case Average Drawdown ($1,976) ($2,176) ($2,259) ($2,308) Worst Case Max. Drawdown ($229,560) ($295,316) ($340,234) ($446,064) Worst Case Average Drawdown ($26,115) ($29,168) ($30,588) ($33,182)

Max Number of Contracts 1 1 1 $132,590 $50,000 $182,590 1,051 370 681 $3,900 $1,120 ($810) ($414) Worst Case Max. Drawdown ($10,292) ($16,136) ($17,908) ($21,364)

Thi$ %able $h!($ %ha% %he $5000 fi)ed #a%i! MM %#ade$ &" %! 27 l!%$ $im&l%a e!&$l*. Thi$ MM lead$ %! a %!%al e% "#!fi% !f !'e# $1.5 milli! , c!m"a#ed %! %he $132,000 (he %#adi g ! e fi)ed l!%. The "#ice f!# %he highe# gai i$ highe# #i$k. The MM i c#ea$e$ %he la#ge$% l!$i g %#ade %! $15,418 (f#!m $810) a d %he ma)im&m d#a(d!( %! $229,560 (f#!m $10,292). The M! %e Ca#l! a al*$i$ #e'eal$ %ha% %he (!#$% ca$e d#a(d!( (hich ca ha""e (i%h 1% "#!babili%* ($i ce (i%h 99% i% i$ a'!ided) i$ !( $446,064 (f#!m $21,364).

174

Position sizing example, using the LUXOR system

7.4 Conclusion
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

175

Part III:
Systematic Portfolio Trading

8
Dynamic portfolio construction
/H ?:K MABL ;HHD A:L LAHPG F>MAH=L MH =>O>EHI, M>LM :G= >O:EN:M> LBG@E> MK:=BG@ LRLM>FL. 0ABL ?BG:E L><MBHG =>:EL PBMA MA> JN>LMBHG H? AHP MH <HF;BG> =B??>K>GM MK:=BG@ LRLM>FL :G= F:KD>ML MH <HGLMKN<M : IHKM?HEBH. 0A> MHIB< BL MHH E:K@> MH IKHOB=> : <HFIE>M> HO>KOB>P BG MABL ;HHD, ;NM BG CA:IM>K 8 :G= MA> :II>G=BQ P> A:O> IKHOB=>= LHF> IK:<MB<:E MBIL ?KHF HNK HPG >QI>KB>G<>.

8.1 Introduction to portfolio construction


!O>G B? F:GR MK:=>KL :K> :P:K> H? MA> GHMBHG MA:M MK:=BG@ : IHKM?HEBH H? FNEMBIE> LRLM>FL HG MA> L:F> :LL>M, HK MA> L:F> LRLM>F HG FNEMBIE> :LL>ML, HK ;HMA, LFHHMAL MA> HO>K:EE >JNBMR EBG>, ?>P MK:=>KL M>LM :G= HIMBFBL> : LRLM>F PBMA MABL I>KLI><MBO> BG FBG=. +G> FHMBO> ?HK MABL BG MA> I:LM F:R A:O> ;>>G MA:M MA> FHLM <HFFHG M><AGB<:E :G:ERLBL I:<D:@>L =B= GHM :EEHP MK:=>KL MH IKH=N<> : IHKM?HEBH >JNBMR EBG> >:LBER. *HP:=:RL MABG@L A:O> <A:G@>= :G= F:GR LH?MP:K> AHNL>L H??>K IKH=N<ML MA:M :EEHP MK:=>KL MH M>LM : FNEMBF:KD>M FNEMB-LRLM>FL IHKM?HEBH.

179

Trading Systems

A list of the main available software


Market System Analyzer (www.adaptrade.com)
0ABL BL <A>:I :G= LF:KM LH?MP:K> MA:M ?HK :L EBMME> :L $349 <:G =H PA:M>O>K RHN G>>= BG MA> P:R H? IHKM?HEBH M>LMBG@. %M :EEHPL RHN MH BFIHKM LRLM>F K>IHKM =:M: ?KHF 0K:=>/M:MBHG BG !Q<>E ?HKF:M, >O>G B? RHN G>>= MH =H BM ?HK >O>KR LBG@E> LMH<D HK ?NMNK> BG MA> IHKM?HEBH, (:G= MABL BL JNBM> MBF>-=>F:G=BG@.) %M I>K?HKFL >JNBMR EBG> <KHLLHO>KL, )HGM> C:KEH :G:ERLBL, MK:=> =>I>G=>G<R :G= IHKM?HEBH :G:ERLBL.

MultiChart (www.tssupport.com)
0ABL BL : IKH=N<M MA:M <HLML $1497 ?HK : EB?>MBF> EB<>G<>. %M A:L : AN@> <AHB<> :FHG@ =B??>K>GM =:M: ?>>=L :G= BM BL !:LR (:G@N:@> <HFI:MB;E>. %M <:G I>K?HKF =B??>K>GM HIMBFBL:MBHG :G= ;:<D-M>LMBG@ M>LML HO>K : IHKM?HEBH.

Mechanica (www.mechanicasoftware.com)
0A> ?HKF>K 0K:=BG@ .><BI>L A:L ;>>G NI=:M>= :G=, :?M>K K>LA:IBG@, A:L M:D>G MABL G>P G:F>. %M A:L : LM:G=:K= >=BMBHG MA:M <HLML $3000 :G= : ,KH?>LLBHG:E !=BMBHG MA:M <HLML $25,000. AG NI@K:=> ?KHF MA> HE= 0K:=BG@ .><BI>L <HLML $900.

RINA Systems (www.rinasystems.com)


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

180

Dynamic portfolio construction

The role of correlations


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

181

Trading Systems

LAHPL AHP =B??B<NEM BM BL MH FHO> ?KHF : INK> MA>HK>MB<:E PHKE= MH MA> >O>KR=:R EB?> H? : LRLM>F:MB< MK:=>K. AGHMA>K <KBMBJN> H? : IHKM?HEBH :IIKH:<A ;:L>= HG <HKK>E:MBHG :FHG@ :LL>ML BL MA:M <HKK>E:MBHG BL GHM : LM:MBHG:KR F>:LNK> H? MA> K>E:MBO> ;>A:OBHNK H? MPH =B??>K>GM :LL>ML. BR LM:MBHG:KR P> F>:G MA:M : ?HKF H? <HKK>E:MBHG BL GHM ;HNG= MH E:LM ?HK>O>K, ><HGHFB<L <A:G@> <HKK>E:MBHGL :FHG@ :LL>ML, LH MA:M IK>LNFBG@ MA:M BG HG> R>:K[L MBF> <HKK>E:MBHG PBEE ;> MA> L:F> :L MH=:R <HNE= ;> ?:M:E. (>M[L M:D> MA> >Q:FIE> H? HBE: ><HGHFB>L P>K> FN<A FHK> =>I>G=>GM HG HBE =NKBG@ MA> 1973-74 :G= 1979 LAH<DL MA:G =NKBG@ MA> 2008 ;N;;E>. /H BG?E:MBHG I>KLI><MBO>L =NKBG@ MA> 2008 ;N;;E> P>K> FN<A E>LL BFI>K:MBO> MA>G 30 R>:KL >:KEB>K ;><:NL> 3>LM>KG ><HGHFB>L P>K> FN<A E>LL =>I>G=>GM HG HBE. 0A> NG?BQ>= <A:K:<M>K H? <HKK>E:MBHGL BL : <HGMKHO>KLB:E :K>: MA:M MA>HK>MB<:E IHKM?HEBH <HGLMKN<MBHG L>>FL GHM MH <HGLB=>K BG :G :IIKHIKB:M> P:R.

Publications and theoretical tools


AFHG@ :<:=>FB< I:I>KL MA>K> BL : LAHKM:@> H? @HH= IN;EB<:MBHGL :;HNM IHKM?HEBH <HGLMKN<MBHG PBMA :G :E@HKBMAFB< :IIKH:<A. +G> :NMAHK MA:M MKB>= MH ?B@AM :@:BGLM MABL LBMN:MBHG BL 0AHF:L /MKB=LF:G. $> PKHM> MPH BGLIBKBG@ ;HHDL, T&adi#g S,'(e"' Tha( W$& :G= T&adi#g S,'(e"' a#d M$#e, Ma#age"e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

182

Dynamic portfolio construction

Portfolio trading in practice


A LHNG= :IIKH:<A MH IHKM?HEBH MK:=BG@ BL LHF>MABG@ MA:M BL ;:L>= HG LHNG= :G= IKN=>GM IK>FBL>L. B>MM>K, HG L<>IMB<:E IK>FBL>L. /<>IMB<BLF BG JN:GMBM:MBO> MK:=BG@ BL MA> ;>LM KNE> RHN <:G :IIER LBG<> BM EHP>KL KBLD. %M BL A:K= MH A:O> =HN;ML :;HNM >O>KRMABG@ ;NM B? RHN @>M :<<NLMHF>= MH BM RHN PBEE :KKBO> :M MA> <HG<ENLBHG MA:M MA>K> :K> CNLM : ?>P M>G>ML MA:M :K> K>:EER L:?> ?HK : MK:=>K. 3> PBEE GHP K>OB>P LHF> A:K=->:KG>= E>LLHGL P> A:O> @:BG>= MAKHN@A >QI>KB>G<>:

The more the better


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

A price series is a price series and nothing more than a price series
A MK:=BG@ LRLM>F LAHNE= IKH=N<> @HH= K>LNEML HG : IKB<> L>KB>L :G= GHM ?HK<>=ER HG : IK><BL> GNF;>K H? HMA>K IKB<> L>KB>L. 0AHF:L /MKB=LF:G :K@N>L MA:M A> NLN:EER M>LML : LRLM>F HO>K 30-60 F:KD>ML :EHG@ 20 R>:KL :G= A> P:GML BM MH I>K?HKF FH=>K:M>ER P>EE HG :M E>:LM MPH-MABK=L H? :EE F:KD>ML (L>> 718). 3> MABGD MA:M MABL BL : LHIABLMB<:M>= :IIKH:<A

183

Trading Systems

:G= P> :@K>> PBMA BM, ;NM P> A:O> >G<HNGM>K>= HGER : ?>P MK:=BG@ LRLM>FL MA:M P>K> LN<<>LL?NE HG :EE F:KD>ML. %G F:GR <:L>L LRLM>FL NLN:EER PHKD PBMA MA> L:F> >??B<B>G<R HG ?NMNK>L MA:M ;>EHG@ MH MA> L:F> <:M>@HKR: ;HG=L, <NKK>G<B>L, LMH<D BG=>Q>L, <>K>:EL, >M<. AL LM:M>= :;HO>, MA>K> BL GHM : <E>:K K><BI> ?HK LN<<>LL :G= RHN <:G HGER MK:=> PBMA MA> LRLM>FL RHN A:O> :M RHNK =BLIHL:E MH=:R. %? RHNK LRLM>FL PHKD HG :EE MA> F:KD>ML RHN PBEE MK:=> HG :EE MA> F:KD>ML, ;NM B? MA>R CNLM PHKD HG MAK>> =B??>K>GM F:KD>ML MA>R LAHNE= GHM ;> =BL<:K=>= CNLM ?HK MABL K>:LHG.

We know what happened today but we have no means of knowing what will happen tomorrow
C:G<>E >O>KR X>LMBF:M>Y ?KHF RHNK =B<MBHG:KR PA>G RHN ;NBE= : MK:=BG@ LRLM>FL[ IHKM?HEBH. 0A>K> :K> LHF> :NMAHKL MA:M <E:BF MA:M RHN G>>= MH ?B@NK> HNM RHNK X>LMBF:M>= IHKM?HEBH K>MNKG :G= O:KB:G<>Y BG HK=>K MH =><B=> FHG>R F:G:@>F>GM, LRLM>FL :G= F:KD>ML L>E><MBHG. 0ABL BL MA> PKHG@ :IIKH:<A ;><:NL> MA> O>KR K>:LHG P> :K> NLBG@ MK:=BG@ LRLM>FL BL ;><:NL> P> =H GHM DGHP AHP MH IK>=B<M MA> ?NMNK> :G= G>BMA>K MA> >QI><M>= :O>K:@> K>MNKGL :G= O:KB:G<> <:G ;> >LMBF:M>=.

If we limit risks, profits will take care of themselves


3> <:GGHM <HGMKHE MA> IKH?BM H? : IHLBMBHG PAB<A P> >GM>K>= PBMAHNM MA> LNIIHKM H? :G >LMBF:M>. 3A:M P> <HGMKHE BL MA> KBLD; MA:M BL MA> =B??>K>G<> ;>MP>>G MA> >GMKR IKB<> :G= MA> LMHI EHLL. 0ABL BL PA:M P> G>>= MH :G:ERL> BG HK=>K MH IKHM><M HNK <:IBM:E. 0ABL BL : =>?>GLBO> :IIKH:<A MH LRLM>F:MB< IHKM?HEBH MK:=BG@ :G= BM FNLM ;> <E>:K MA:M BM =H>L GHM >Q<EN=>, HG<> IKHI>KER K>L>:K<A>=, HMA>K IHKM?HEBH <HFIHLBMBHG F>MAH=HEH@B>L. AL LAHNE= ;> <E>:K ?KHF MA> ;HHD, : MK:=>K LAHNE= :LL>LL :EE MA> MK:=BG@ F>MAH=HEH@B>L :G= MHHEL MA> BG=NLMKR IKHOB=>L, ;NM BM BL :EP:RL IKN=>GM MH :IIER HGER MAHL> F>MAH=HEH@B>L MA:M A> <:G ?NEER <HGMKHE :G= NG=>KLM:G=. 0A> ?HNK IHBGML :;HO> :K> : DBG= H? ;HMMHF EBG> BG LRLM>F:MB< IHKM?HEBH MK:=BG@. %G MA> EBM>K:MNK> :;HNM MK:=BG@ LRLM>FL MA>K> :K> K>:EER ?>P B=>:L HG AHP MH <HFIHL> : IHKM?HEBH; MA:M BL, PAB<A F:KD>ML MH MK:=> :G= PAB<A LRLM>FL MH :IIER MH PAB<A F:KD>ML. 1LN:EER BG HNK ;NLBG>LL, PA>K> MA>K> BL : E:<D H? BG?HKF:MBHG :;HNM : LI><B?B< MHIB< BM F>:GL MA:M LHF> @HE= GN@@>ML :K> AB==>G LHF>PA>K>. ,HKM?HEBH <HFIHLBMBHG BL HG> LN<A :K>: MA:M ?HK R>:KL A:L GHM ;>>G :;E> MH HO>K<HF> LHF> NL>E>LL B=>:L LN<A :L MA> 3BE=>K[L CHFFH=BMR />E><MBHG %G=>Q HK HMA>K FHK> LHIABLMB<:M>= :IIKH:<A>L ?NEE H? >LMBF:M>L, MA> HKB@BGL H? PAB<A GH;H=R DGHPL.

184

Dynamic portfolio construction

(>M[L EHHD :M LHF> IK:<MB<:E P:RL MH ;NBE= : LRLM>FL IHKM?HEBH. 0A>L> :IIKH:<A>L :K> K>:E HG>L :G= A:O> ;>>G :IIEB>= >BMA>K ;R NL HK ;R MA> ;>LM MK:=BG@ LRLM>FL =>O>EHI>KL P> A:O> F>M BG MA> E:LM =><:=>. 3> PBEE GHM =>EO> BGMH MA> BGMKB<:<B>L H? >:<A HG> ;><:NL> MABL PHNE= M:D> NL MHH ?:K :P:R ?KHF HNK I:MA. 3AB<A>O>K F>MAH= RHN =><B=> NIHG, IE>:L> M>LM BM <:K>?NEER ;>?HK> MK:=BG@. %G MABL <A:IM>K P> PBEE IBGIHBGM LHF> ABGML :;HNM IKHL :G= <HGL RHN PBEE >G<HNGM>K PBMA >O>KR IHKM?HEBH <HGLMKN<MBHG F>MAH=. 1G?HKMNG:M>ER P> =H GHM A:O> : =>?BGBM> PHK= :;HNM MABL LN;C><M: P> ;>EB>O> MA:M IHKM?HEBH <HFIHLBMBHG F>MAH= <:G H?M>G =>I>G= HG PAB<A LRLM>FL RHN :K> :=HIMBG@, :G= HO>K :EE BM PBEE ;> :??><M>= ;R PA>MA>K RHN :K> MK:=BG@ F:GR F:KD>ML PBMA MA> L:F> LRLM>FL, F:GR F:KD>ML PBMA F:GR LRLM>FL HK HG> F:KD>M PBMA F:GR LRLM>FL.

Total vs. partial equity contribution


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

185

Trading Systems

;><:NL> RHN :K> GHM :;E> MH DGHP BG :=O:G<> PAB<A F:KD>M PBEE MK>G= :G= PAB<A F:KD>M PBEE ;> BG <HG@>LMBHG. %? RHN A:O> : MK>G=-?HEEHPBG@ LRLM>F :G= : <HNGM>K-MK>G= LRLM>F RHN <:G IKN=>GMER MK:=> :EE MA> F:KD>ML HK >O>G :IIER MA> MK>G= ?HEEHPBG@ LRLM>F MH MA> MK:=BMBHG:EER OHE:MBE> F:KD>ML :G= MA> <HNGM>K MK>G= MH MA> MK:=BMBHG:EER <AHIIR F:KD>ML. 0ABL L><HG= LHENMBHG BL H;OBHNLER FHK> A:S:K=HNL MA:G MA> ?BKLM ;NM MA>K> :K> :==BMBHG:E MHHEL MA:M <:G EHP>K MA> KBLD.

Partial equity contribution


AGHMA>K LHENMBHG PHNE= ;> MH M>LM MA> LRLM>FL HG :EE MA> F:KD>ML :G= MA>G <AHHL> : ?BQ>= ?K:<MBHG H? MA> ;>LM I>K?HKFBG@ F:KD>ML :<<HK=BG@ MH MA> ;KH:= <:M>@HKR MH PAB<A MA>R ;>EHG@: <>K>:EL, >G>K@B>L, <NKK>G<B>L, LMH<D BG=>Q>L, ;HG=L, >M<. 0ABL IHKM?HEBH BL : DBG= H? <HFIKHFBL> ;>MP>>G MA> MHM:E <HGMKB;NMBHG :G= MA> :EE F:KD>ML <AHB<> :G= BM BL G>BMA>K MHH :@@K>LLBO> GHK MHH =>?>GLBO>. 0ABL F>MAH= <HNE= ;> MA> X@HE=>G FB==E>Y.

8.2 Correlation among equity lines


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

186

Dynamic portfolio construction

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
Figure 8.1: Matrix of linear correlations among monthly equity lines of one of our portfolios traded with real money.

BO BO C (0.2465) CL FGBL

C
(0.2465)

CL
0.0845

FGBL

GC

JY
0.2678

QM
0.2458

SF
0.2354 0.1085 0.1630 0.2673 0.0285

SM

TY

US

S
0.4830 0.4600

EC
0.0962 0.0082 0.0691 0.0000 0.2711 0.1176 0.1926 0.1664 0.2108

0.0971 (0.0162)

0.1481 (0.0178) 0.0349 0.1350

0.0081 0.5000 0.1129 0.0315

(0.0218) (0.0334)

0.0944 (0.1478) (0.1656) 0.1159 0.5514 0.1421 0.0462

0.0845 (0.0218) 0.0971 (0.0334) 0.0502

0.0502 (0.0024)

0.0755 (0.0019) 0.1600 0.3054

0.0158 0.0920 (0.0345) 0.1733 0.0439 (0.0551) 0.1981 0.2511 0.0669 0.2008 0.2007

(0.1612) (0.0187) (0.0351)

GC (0.0162) JY QM SF SM

0.0944 (0.0024) (0.1612) 0.1159 (0.0187) (0.0351) 0.5514 0.1630 0.0755 0.1421 0.2673 0.1600 0.0462

0.1195 (0.0360) (0.0838) 0.0437 0.0971 (0.1208) (0.0050) 0.2806 0.1419 (0.0835) (0.1079) 0.1026 0.0704 0.0075 (0.0880) 0.0089 0.1198 0.0172 0.0498 0.3063 0.0197 0.3063 0.0197 0.0159 0.0841 0.0363 0.4674 0.0100 0.0616 0.0841

0.2678 (0.1478) 0.2458 (0.1656) 0.2354 0.1481 0.1085 0.0349

0.1819 (0.0304) 0.1819 0.2274 0.1419 0.0704 0.2274

0.0285 (0.0304) 0.1195 0.0971

TY (0.0178) US W S EC
0.0081 0.5000 0.4830 0.0962

0.1350 (0.0019) 0.1129 0.0315 0.0158 0.0920

0.3054 (0.0360) (0.1208) (0.0835) 0.1733 (0.0838) (0.0050) (0.1079) 0.0439 0.0437 0.1981 0.2711 0.2806 0.2511 0.1176 0.1026 0.0669 0.1926

0.0075 (0.0880) 0.0089 0.1198 0.2008 0.1664 0.0172 0.0498 0.2007

0.0159 (0.2185) 0.0363 0.4674 0.0100 0.0616 0.2080 0.2080

0.4600 (0.0345) (0.0551) 0.0082 0.0691 0.0000

0.2108 (0.2185)

6 7

/>> PPP.KBG:?BG:G<B:E.<HF />> PPP.:=:IMK:=>.<HF

187

Trading Systems

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

8.3 A dynamic approach: equity line crossover


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

188

Dynamic portfolio construction

I>KBH= FHOBG@ :O>K:@> H? MA> >JNBMR EBG> BML>E? :G= LMHI MK:=BG@ PBMA : LRLM>F PA>G MA> HIIHLBM> BL MKN> ("B@NK> 8.2). 0A> L:F> <KHLLHO>K KNE> <HNE= :ELH ;> :IIEB>= MH MA> PAHE> IHKM?HEBH H? LRLM>FL :L : L><HG= L><NKBMR F>:LNK> :?M>K ;>BG@ :IIEB>= MH MA> LBG@E> LRLM>F. %G MABL <:L> BM PHNE= ;> IKHI>K MH =BLMBG@NBLA ;>MP>>G : IHKM?HEBH H? =:BER LRLM>FL (BM PHNE= GHM ;> :=OBL:;E> MH >QBM : MK:=> HG : =:BER MK:=BG@ LRLM>F LBFIER ;><:NL> MA> IHKM?HEBH >JNBMR EBG> =KHII>= ;>EHP BML :O>K:@>) :G= : IHKM?HEBH H? BGMK:=:R MK:=BG@ LRLM>FL. %G HNK >QI>KB>G<> BM BL GHM : LNK> MABG@ MA:M MABL >JNBMR EBG> <KHLLHO>K :IIKH:<A PBEE PHKD >JN:EER P>EE HG :EE LRLM>FL :G= :EE F:KD>ML. %? MA> LRLM>F BL : @HH= HG>, B? BM =H>L GHM A:O> MHH F:GR KNE>L :G= B? BM BL IKHI>KER HIMBFBL>= :G= >JN:EER IKHI>KER K>-HIMBFBL>= :M I>KBH=B< BGM>KO:EL, BM BL EBD>ER MA:M MA> >JNBMR EBG> <KHLLHO>K :IIKH:<A PBEE G>O>K >G<HNGM>K : =HPGP:K= <KHLLHO>K. /H B? MA> LRLM>F BL MHH @HH=, :IIERBG@ MABL :IIKH:<A PBEE G>O>K BFIKHO> MA> HO>K:EE LRLM>F K>LNEML. $HP>O>K, :IIERBG@ MA> >JNBMR EBG> <KHLLHO>K MH MA> PAHE> IHKM?HEBH H? LRLM>FL PBMA : PAHE> IHKM?HEBH >JNBMR EBG> BL : MHHE MA:M <:G A>EI MA> MK:=>K IK>O>GM MA> GB@AMF:K> H? MA> X;E:<D LP:GY PA>G >O>KRMABG@ @H>L PKHG@. 1LN:EER MA> >JNBMR EBG> <KHLLHO>K BL : =RG:FB< MHHE MA:M K>=N<>L MA> KBLD FHK> >??><MBO>ER MA:G MA> NL> H? MA> LBFIE> =K:P=HPG. )HK>HO>K, MA> LBFIE> =K:P=HPG KNE> HK : FNEMBIE> H? BM A:L GH <HKK>LIHG=BG@ <HGMK:KR KNE> MH :<MBO:M> : X=HKF:GMY LRLM>F, PA>K>:L HNK IKHIHL>= L><NKBMR KNE> <:G @BO> MABL BG=B<:MBHG.

189

Trading Systems

Figure 8.2: The blue line is the 30-period moving average and the red line is the 1-period equity line. At point A there was a down crossover and trading was stopped. At point B there was an upward crossover and trading was resumed.

8.4 Dynamic portfolio composition: the walk forward analysis activator


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

190

Dynamic portfolio construction

Figure 8.3: this is an example on how Fabrizio Bocca and Cristiano Raco rank their trading systems farm though WFA. On the right corner there is a column denominated RCD where the WFA results are condensed in a comprehensive index. If the index is positive the trading system is traded with real money, if it is negative (zero in the column) is it deactivated.

N. 1 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.

Trading System Euro Rev Br Open Week Bund Bund Kagi Daily Gold Kagi Daily Euro Nightmare Bund Big Deep Dax Castle TBond DBZ Mazzle Dax TBond Kagi Daily Crude Oil Multi Fib Castle Big Deep US Vit Daily Bond US Open Week Dax Open Week Spmib

MM 15 30 30 30/15 15 30 15 30 15 15/30 30 15

P16 Months 0,183 1,338 6,039 -1,000 5,951 4,193 0,235 1,754 2,983 3,954 0,387 -1,000

PI 12 Months 8,443 2,054 1,826 2,069 4,314 6,540 1,237 1,918 3,871 1,682 -0,477 -0,034

MI 13 Years 12,729 10,262 7,837 6,349 4,135 3,477 3,832 4,918 2,564 2,525 2,013 1,122

PI Years 10,422 17,404 11,500 11,016 7,210 2,690 9,649 4,510 4,044 5,966 3,318 4,302

RCD 9,314 8,300 6,797 5,110 5,067 4,193 3,807 3,612 3,250 3,217 1,407 1,151 0,000 0,000 0,000 0,000

191

Trading Systems

8.5 Largest losing trade/largest losing streak/largest drawdown


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

192

Conclusion
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

193

Trading Systems

*HP P> DGHP PA:M RHN MABGD: B? RHNK B=>:L :K> =BL<EHL>= MH : IKH@K:FF>K MA>G A> PBEE F:D> FHG>R PBMA MA>F. BNM MA>K> :K> F:GR IHBGML :@:BGLM MABL B=>:. 0A> ?BKLM BL MA:M B? RHNK IKH@K:FF>K F:D>L FHG>R PBMA RHNK B=>:L MABL PBEE GHM IK>O>GM RHN ?KHF F:DBG@ FHG>R PBMA MA>F :EE MA> L:F>. 3> A:O> :EK>:=R =BL<NLL>= MA:M RHN <:G IN;EBLA RHNK LRLM>F BG MA> Wa!! S(&ee( J$)&#a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

194

Conclusion

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

195

Trading Systems

!O>KR F>MAH=HEH@R P> AB@AEB@AM>= BG MABL ;HHD :EHG> PBEE GHM ;> MA> NEMBF:M> D>R ?HK : IKH?BM:;E> LRLM>F:MB< MK:=BG@ ;NM :EE INM MH@>MA>K MA>R PBEE I:BGM : <E>:K>K IB<MNK> BG PAB<A RHN <:G FHO> <HF?HKM:;ER CNLM HPGBG@ : LBFIE> MK:=BG@ LRLM>F[L <H=>.

(>M[L K>OB>P :EE MA> F>MAH=HEH@B>L :G= MKR MH LNFF:KBL> MA> IKHL :G= <HGL H? >:<A H? MA>F.

Rule complexity
%M BL ;>MM>K MH MK:=> PBMA : LRLM>F PBMA ?>P BGINML, ?>P O:KB:;E>L :G= :G >JNBMR EBG> MA:M BL GHM ABLMHKB<:EER >QABE:K:MBG@ BGLM>:= H? 100 BGINML HK O:KB:;E>L :G= : LNI>K >JNBMR EBG>.

Testing
H GHM INM RHNK ?H<NL HG : ;NG<A H? F:KD>ML :G= ?HK@>M MA> HMA>K HG>L. *H;H=R <HNE= M>EE RHN MA:M : LRLM>F =H>L GHM I>K?HKF HG : F:KD>M ;NM <HNE= ;> MA> PBGGBG@ MHHE ?HK MK:=BG@ MA> K>F:BGBG@ 50 F:KD>ML. /N;L<KB;> MH : =:M: O>G=HK LN<A :L C/% =:M: (PPP.<LB=:M:.<HF) HK ,BGG:<E> =:M: (PPP.IBGG:<E>=:M:.<HF) :G= MA>G :IIER RHNK LRLM>FL HG :M E>:LM 70 =B??>K>GM ?NMNK>L =:BER IKB<> L>KB>L ;>?HK> :KKBOBG@ :M MA> <HG<ENLBHG MA:M MA> <H=> =H>L GHM PHKD.

Optimisation
+IMBFBL:MBHG BL @HH= B? BM BL I>K?HKF>= BG : L:OOR P:R. 5HN LAHNE= K>-HIMBFBL> K>@NE:KER, :?M>K : ?BQ>= MBF> I>KBH= BG HK=>K MH D>>I MA> LRLM>F BG LRG<AKHGBL:MBHG PBMA MA> F:KD>M.

Monte Carlo analysis


0ABL BL : @HH= IKH<>LL BG HK=>K MH <A><D MA> LM:;BEBMR H? MA> LRLM>F BG : IKH;:;BEBLMB< P:R ;NM BML BFIHKM:G<> LAHNE= GHM ;> HO>K-LMK>LL>=. %? MA> LRLM>FL BL HO>K-HIMBFBL>= MA> )HGM> C:KEH :G:ERLBL PBEE ;> I>K?><M ;NM MABL =H>L GHM F>:G :GRMABG@.

196

Conclusion

Portfolio building
%? RHN :K> MK:=BG@ :G >:LR <H=> EBD> : <A:GG>E ;K>:DHNM, HK : FHOBG@ :O>K:@> HG : ;NG<A H? IHKM?HEBHL MH <AHHL> MA> KB@AM IKB<>L L>KB>L MH ;> MK:=>=, MABL BL : OBM:E IHBGM ?HK LN<<>LL. 3> =>IB<M>= F:GR P:RL MH :IIKH:<A MABL IKH;E>F, ;NM MA> ?BG:E LHENMBHG PBEE =>I>G= FHK> HG MA> >QI>KB>G<> H? MA> MK:=>K MA:G HG : IK><BL> KNE>.

Dynamic risk management


H GHM K>ER HG : ?BQ>= KNE> BG HK=>K MH :<MBO:M> HK LMHI : LRLM>F ?KHF MK:=BG@. 5HN G>>= MH KNG : ?:KF H? : =HS>G MK:=BG@ LRLM>FL :G= MA>G :<MBO:M> MAHL> MA:M :K> ?BM ?HK MA> <NKK>GM MK:=BG@ >GOBKHGF>GM. 0A> FHOBG@ :O>K:@> >JNBMR EBG> <KHLLHO>K BL MABL DBG= H? MHHE MA:M <:G MK:GL?HKF : F>=BH<K> LRLM>F BGMH : IHP>K?NE MK:=BG@ F:<ABG>.

Money management
0ABL BL HG> H? MA> FHLM BFIHKM:GM ?:<MHKL BG MK:=BG@, :EP:RL D>>I RHNK KBLD >QIHLNK> E>LL MA:G 1% ?KHF MA> >GMKR IHBGM I>K >O>KR MK:=>, ;>MM>K MH ;> 0.5% BL RHN :K> :;E> MH :??HK= LN<A : EHP KBLD E>O>E.

AL RHN <:G L>> ?KHF MA> :;HO> F>GMBHG>= IHBGML, MA> LRLM>F:MB< MK:=>K A:L :M ABL =BLIHL:E : EHG@ EBLM H? MHHEL MA:M <:G HO>K<HF> MA> PHNE=-;> AB@A>K >??B<:<R H? MA> IKH@K:FFBG@ <HFIE>QBMR PBMAHNM ANKMBG@ MA> IKH?BM :MMK:<MBO>G>LL H? : MK:=BG@ LRLM>F. AG= P> LMK>LL MA:M RHN LAHNE= I:R A>>= MH MABL EBLM BG HK=>K MH BFIKHO> K>LNEML.

197

Appendices
Systems and ideas

%G MA>L> :II>G=B<>L P> A:O> BG<EN=>= MAK>> MK:=BG@ LRLM>FL. 3> >QIE:BG>= MA> ?BKLM MPH BG :KMB<E>L BG T+ade+, F:@:SBG> :G= MA> MABK= HG> P:L >QM>GLBO>ER MK>:M>= PBMABG MABL ;HHD. 0A>L> MAK>> LRLM>FL <:G ;> NL>= :L : LM:KMBG@ IHBGM MH ;NBE= IHKM?HEBHL PBMA MK:=BG@ LRLM>FL.

Appendix 1: Bollinger Band system

1.1 Idea
%G MABL ;HHD P> :EK>:=R NL>= : BHEEBG@>K B:G= LRLM>F MH LAHP MA> >??><M H? HNM-H?-L:FIE> =>M>KBHK:MBHG (CA:IM>K 5.2). 0A> BHEEBG@>K B:G= PAB<A P> NL> GHP MH ;NBE= : LBFIE>, ;NM KH;NLM IHKM?HEBH, P:L =>L<KB;>= BG =>M:BE BG :G >:KEB>K :KMB<E> BG T&ade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

201

Trading Systems

1.2 Entry logic and Easy Language code

Long entry: If the price crosses above the higher Bollinger Band. Enter the market intraday with a buy stop: Enter long: next bar at HigherBand stop;

Short entry: The short entry is symmetrical to the long entry, enter intraday if the price crosses below the lower Bollinger Band. Enter short: next bar at LowerBand stop;

Exit: Exit if the price crosses the moving average between the Bollinger Bands: Exit: next bar at Average(Close,60) stop;

0A> >Q:<M IHLBMBHG H? MA> AB@A>K :G= MA> EHP>K BHEEBG@>K B:G= BL =>M>KFBG>= ;R M:DBG@ MA> LBFIE> FHOBG@ :O>K:@> :G= :==BG@ (AB@A>K ;:G=) HK LN;MK:<MBG@ (EHP>K ;:G=) MA> ?HEEHPBG@, OHE:MBEBMR =>I>G=>GM :FHNGM: BLM:G<> * /M:G=:K= =>OB:MBHG. 0A> OHE:MBEBMR =>I>G=>GM <HFIHG>GM BL EH<:M>= PBMABG MA> LM:G=:K= =>OB:MBHG, PA>K>:L MA> =BLM:G<> BL : ?BQ>= I:K:F>M>K PAB<A <:G ;> O:KB>=.

202

Appendix 1: Bollinger Band system

0A> !:LR (:G@N:@> CH=> BL CNLM LHF> EBG>L:

Inputs: Length(60), Distance(2); Vars: HigherBand(0),LowerBand(0);

HigherBand = Average(Close, Length) + Distance * StdDev(Close, Length); LowerBand = Average(Close, Length) - Distance * StdDev(Close, Length);

Buy next bar at HigherBand stop; Sell next bar at LowerBand stop;

ExitLong next bar at Average(Close, Length) stop; ExitShort next bar at Average(Close, Length) stop;

0A> LRLM>F A:L MPH BGINM I:K:F>M>KL, PAB<A :K> ;HE= MRI>=. +G> K>IK>L>GML MA> E>G@MA H? MA> FHOBG@ :O>K:@>, MA> HMA>K =>M>KFBG>L MA> =BLM:G<> (HK PB=MA) H? AHP ?:K :P:R ?KHF MABL FHOBG@ :O>K:@> MA> BHEEBG@>K B:G=L :K> IE:<>=. 0A>BK =>?:NEM O:EN>L :K> L>M MH : E>G@MA H? 60 :G= =BLM:G<> H? 2. BR <A:G@BG@ MA>L> I:K:F>M>KL RHN <:G :=CNLM MA> MK:=> ?K>JN>G<R. 0A> LF:EE>K RHN L>M MA> E>G@MA ?HK MA> FHOBG@ :O>K:@>, :G= MA> LF:EE>K RHN <AHHL> MA> =BLM:G<> H? MA> BHEEBG@>K B:G=L, MA> ?:LM>K MA> LRLM>F PBEE K>:<M MH F:KD>M <A:G@>L :G= MA> FHK> LB@G:EL RHN PBEE @>M. AL P>EE :L MABL IHLLB;BEBMR MH :=CNLM MA> LRLM>F <H=> MH RHNK I>KLHG:E G>>=L BHEEBG@>K B:G=L A:O> ?NKMA>K :=O:GM:@>L ?HK ;NBE=BG@ F><A:GB<:E MK:=BG@ LRLM>FL. N> MH MA>BK OHE:MBEBMR-;:L>= <HFIHG>GM MA>R <:G >:LBER :=:IM MH =B??>K>GM F:KD>M <HG=BMBHGL. A==BMBHG:EER MA>R IKHOB=> : G:MNK:E >QBM IHBGM ;R NLBG@ MA> FHOBG@ :O>K:@> ;>MP>>G MA> BHEEBG@>K B:G=L.

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1.3 Application of the strategy to seven markets with same parameters


0A> LMK:M>@R BL GHP :IIEB>= MH =:BER =:M: H? L>O>G F:KD>ML ?KHF MAK>> =B??>K>GM F:KD>M @KHNIL: 0AK>> LMH<D BG=>Q ?NMNK>L: *:L=:J-)%*%, !1.+ /0+44 50 :G= /PBLL ):KD>M %G=>Q

0PH ;HG= BG=>Q ?NMNK>L: BNG=, 1/-0-*HM> (10R>:K)

0PH <NKK>G<R ?NMNK>L: !NKH :G= /PBLL "K:G<

:BER =:M: P:L M:D>G ?KHF FB=-1994 NGMBE FB=-2005. :M: LHNK<> ?HK MA> >G=-H?-=:R =:M: P:L C/% 1G?:BK A=O:GM:@> (<LB=:M:.<HF). "HK :EE MA> I>K?HKF>= M>LML >Q:<MER MA> L:F> I:K:F>M>KL (=>?:NEM: E>G@MA=60, =BLM:G<>=2) P>K> M:D>G BG HK=>K MH FBGBFBL> MA> >??><M H? <NKO> ?BMMBG@. AEE K>LNEML :K> ;:L>= HG : HG> <HGMK:<M I>K F:KD>M ;:LBL :G= :K> IK>L>GM>= PBMAHNM LN;MK:<MBHG H? LEBII:@> :G= <HFFBLLBHGL.

1.4 Results and conclusions


0A> <HF;BG>= >JNBMR EBG> H? MA> L>O>G F:KD>ML EHHDL EBD> : @HH= LM:KMBG@ IHBGM ?HK : OB:;E> MK:=BG@ LRLM>F ("B@NK> A1.2). "HK FHK> =>M:BE>= BG?HKF:MBHG A:O> : EHHD :M MA> LRLM>F ?B@NK>L (0:;E> A1.1). 5HN <:G M:D> MABL LRLM>F :G= <HF;BG> BM PBMA HMA>K NG<HKK>E:M>= LRLM>FL/F:KD>ML PBMABG : ;B@@>K IHKM?HEBH. AL F>GMBHG>=, MA> LRLM>F P:L GHM HIMBFBL>= <HG<>KGBG@ MA> BGINM I:K:F>M>KL ?HK MA> >GMKB>L. )HK> BFIHKM:GM MH GHM>, AHP>O>K, BL MA:M P> A:O> GHM BGL>KM>= :G= HIMBFBL>= :GR LI><B:E >QBML BGMH MA> LRLM>F. %? RHN =H MABL BG MA> P:R BM P:L LAHPG BG CA:IM>K 3.5 H? MABL ;HHD, K>LNEML <:G ;> BFIKHO>=, >LI><B:EER <HG<>KGBG@ KBLDL :G= =K:P=HPGL.

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Appendix 1: Bollinger Band system

Figure A1.1: Euro in US dollar, daily, with Bollinger Bands and 60-day moving average of closing prices. The entry and exit points are marked with circles. The crossing of the price and the Bollinger Bands generate the long and short entries. The crossing of the price and the moving average triggers the exits. Chart created with TradeStation 2000i.

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Figure A1.2: Combined equity line of the Bollinger Band system for the portfolio of seven markets, 08/1994-09/2005, for daily data. The figure shows the added net profit on a bar-bybar basis of all trades on these markets without slippage and commissions. Chart created with RINA Systems.

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Appendix 1: Bollinger Band system

Table A1.1: Key figures of the system tests based on end-of-day data. The second table below shows the main figures of the Bollinger Band system for the portfolio of seven markets, 08/1994-09/2005, applied to daily data. The table shows the added results of all trades on these markets without slippage and commissions.

Bollinger Band System


Seven market portfolio
System Analysis Net profit Gross profit Gross loss percent profitable trades Avg. Win/ avg loss. profit factor maximum drawdown average drawdown number of trades average trade $220,943.00 $451,455.50 ($230,512.50) 42.15% 2.69 1.96 ($8,120.00) ($1,424.51) 261 $846.52

Time Analysis (Days) percent in the market longest period out (days) Average time in market average time between trades average time in winning trades average time in losing trades average time to reach new high 82.28% 77.00 59.53 2.14 103.71 27.34 120.10

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Appendix 2: The triangle system


3T!e ,2&&e-+"c -+"a' %e ", ('e (f -!e &(,- )+(f"-ab%e )a--e+', f(+ ,!(+---e+& -+ad"' .4 [15]

2.1 Idea
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2.2 Programming and coding


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Appendix 2: The triangle system

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

2.3 Application to different liquid futures markets with same parameters


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2.4 Advantages in building a portfolio


A O>KR IHLBMBO> LB=> >??><M H? MA> LRLM>F[L EHP F:KD>M >QIHLNK> BL : O>KR EHP <HKK>E:MBHG H? MA> LRLM>F[L K>LNEML PA>G :IIEB>= MH MA> ?HNK =B??>K>GM F:KD>ML LBFNEM:G>HNLER (0:;E> A2.1). 5HN <:G L>> MA:M MA> <HKK>E:MBHGL H? :EE ?HNK LRLM>FL[ K>LNEML :K> G>:KER 0, MA>R O:KR ;>MP>>G : O>KR LF:EE G>@:MBO> <HKK>E:MBHG H? -0.002 :G= : LF:EE IHLBMBO> <H>??B<B>GM H? 0.024. 0ABL IK:<MB<:EER NG<HKK>E:M>= ;>A:OBHNK H? MA> ?HNK F:KD>ML A>EIL MH ;NBE= : AB@A K>MNKG/EHP KBLD IHKM?HEBH PA>G <HF;BGBG@ MA>F. 5HN <:G :ELH L>> MA:M PABE> MA> F:QBFNF >JNBMR =K:P=HPGL H? MA> ?HNK LBG@E> F:KD>ML O:KR ;>MP>>G -$2,440 (/&,400 )B=C:I) :G= -$4,590 (1/ 0K>:LNKR BHG= "NMNK>) MA> F:QBFNF >JNBMR =K:P=HPG H? MA> ?HNKF:KD>M IHKM?HEBH BL BG MA> L:F> :K>: PBMA -$3,275. /H PABE> MA> IKH?BM H? MA> IHKM?HEBH @KHPL BG : EBG>:K P:R PBMA MA> :==>= F:KD>ML MH HO>K $58,000, MA> F:QBFNF =K:P=HPG BL D>IM BG MA> :K>: H? HG> LBG@E> F:KD>M. 0ABL K>LNEML BG : O>KR LM>:=R IHKM?HEBH >JNBMR <NKO> ("B@NK> A2.4). %M BL PHKMA F>GMBHGBG@ MA:M >O>G PBMABG MA> ?HNK-F:KD>M IHKM?HEBH MA> LRLM>F BL HGER BG MA> F:KD>M ?HK 10% H? MA> MBF>. /H MA> F:KD>M >QIHLNK> BL O>KR EHP, PAB<A PHNE= :EEHP RHN MH :== ?NKMA>K LRLM>FL HK F:KD>ML MH MA> IHKM?HEBH. 0A> MK:=> LM:MBLMB<L K>O>:E MA:M MA> @:BGL H? MA> LRLM>F =HG[M <HF> ?KHF : AB@A PBGGBG@ I>K<>GM:@> (53%), ;NM ?KHF MA> ?:<M MA:M MA> :O>K:@> PBGGBG@ MK:=> BL : AN@> :FHNGM ;B@@>K (?:<MHK 1.4) MA:G MA> :O>K:@> EHLBG@ MK:=>. "NKMA>KFHK>, MA> :O>K:@> MBF> BG MK:=>L BL O>KR LF:EE, :M 0.3 =:RL. 0ABL LAHPL MA:M MA> LRLM>F <:IMNK>L F:BGER =RG:FB< ;K>:DHNML PAB<A A:II>G O>KR ?:LM :G= HGER E:LM ?HK : LAHKM MBF>. 0A> LRLM>F ?B@NK>L K>O>:E : ?NKMA>K JN:EBMR H? MA> MKB:G@E> LRLM>F: MA> >JN:E P>B@AM H? EHG@ :G= LAHKM MK:=>L. "KHF MA> MHM:E 625 MK:=>L EHG@ :G= LAHKML G>:KER A:O> MA> L:F> GNF;>K (322 OL. 303) :G= MA> IKH?BML :K> G>:KER =BOB=>= >JN:EER ;>MP>>G MA> EHG@ :G= LAHKM LB=>. 0ABL :IIEB>L ?HK MA> LBG@E> F:KD>ML :G= :L P>EE ?HK MA> <HF;BG>= IHKM?HEBH. 0ABL ?>:MNK> BL MA> K>LNEM H? MA> <HGLMKN<MBHG H? MA> MK:=BG@ EH@B<, PAB<A E>ML MA> F:KD>M BML>E? =><B=> BG PAB<A =BK><MBHG BM @H>L :G= CNLM ?HEEHPL BM, PBMA MA> L:F> IKH;:;BEBMR BG MA> EHG@ :G= BG MA> LAHKM =BK><MBHG.

2.5 Conclusion
0A> >Q:FIE> H? MA> MKB:G@NE:K I:MM>KG <E>:KER LAHPL MA> =B??>K>GM M:LDL H? =BL<K>MBHG:KR :G= LRLM>F:MB< MK:=>KL. 3ABE> =BL<K>MBHG:KR MK:=>KL <:G K>ER HG MA>BK >QI>KB>G<>L :G= MA>BK :;BEBMR MH >LMBF:M> MA> F:KD>M <HKK><MER, LRLM>F:MB< MK:=>KL G>>= MH :<M BG : =B??>K>GM P:R. AL F:GR I:MM>KGL PAB<A :K> >:LR OBLB;E> PBMA MA> ANF:G >R> <:GGHM ;> IKH@K:FF>=

212

Appendix 2: The triangle system

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
Figure A2.1: Principle of the symmetrical triangle pattern, discretionary view. Euro, Globex, 5 Minute, 21-24 January 2007. A natural profit target can be derived from the width of the triangle. False breakouts usually occur which make triangles difficult to program for systematic trading. The final breakout takes place with volume increase and leads the price into the target region.

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Figure A2.2: Principle of programmed triangle system. At the point before the breakout occurs (set-up point) the volatility is extremely low and the moving average tends sideways. If these two conditions are true, a long stop and a short stop entry order is placed. These entry levels also work as natural initial stop and reverse points. A profit target is derived from recent highs and lows (yellow lines).

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Figures A2.3a-d: Result of triangle system on four different markets: 6/2/2002-6/2/2007, $30 S&C per RT, on a day-to-day basis. A2.3a: Euro/dollar Future (TradeStation symbol @EC)

Equity curve detailed @EC 5 min(02/06/02 00:15 02/06/07 14:15

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A2.3b: S&P 400 MidCap Future (TradeStation symbol @EMD.D)

Equity curve detailed @EMD.D 5 min(02/06/02 15:40 02/05/07 22:15

216

Appendix 2: The triangle system

A2.3c: US T-Bond Future (TradeStation symbol @US.P)

Equity curve detailed @US.P 5 min(02/06/02 14:25 02/06/07 14:40

217

Trading Systems

A2.3d: Light Crude Oil Future (TradeStation symbol @CL.C)

Equity curve detailed @CL.C 5 min(02/06/02 00:10 02/06/07 13:35

218

Appendix 2: The triangle system

Figure A2.4: Equity curve of 4-market portfolio. Triangle system applied with same system parameters to the following markets: euro/dollar Future, S&P400 MidCap Future, US T-Bond Future and Light Crude Oil Future. Equally weighted on a one-contract basis, including $30 S&C per RT, Jan 2002-Jan 2007, calculated on a day-to-day basis. Chart created with RINA Systems.

Detailed equity curve 0 (01/21/2002 1/19/2007)

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Trading Systems

Table A2.1: Portfolio figures, Jan 2002-Jan 2007. Portfolio figures of Triangle system applied to the following markets: Euro/dollar Future, S&P400 MidCap future, US T-Bond-Future and Light Crude Oil Future. Same system parameters for all markets, $30 S&C per RT, calculated on a day-to-day basis.

Market 1. Euro 2. S&P 400 3. US-T-Bond

Net Max. Net Profit Profit Drawdown Long $15,915 $11,280 $12,019 -$4,575 -$2,440 -$4,590 -$3,050 -$3,275 $8,693 $6,810 $9,556 $9,570 $34,629

Net Profit Number Average Percent Short of Trades Trade Profitable $7,222 $4,470 $2,463 $9,470 $23,625 197 149 140 139 625 $81 $76 $86 $137 $93 49% 54% 57% 53% 53%

4. Light Crude $19,040 Oil Portfolio $58,254

Correlations S&P 400 Euro Light Crude Oil US-T-Bond

S&P 400

Euro 0.019

Light Crude Oil 0.020 -0.002

US-T-Bond -0.002 0.024 0.006

0.019 0.020 -0.002 -0.002 0.024

0.006

220

Appendix 3: Portfolios with the LUXOR trading system


%G CA:IM>K 3 P> IK>L>GM>= MA> MK>G=-?HEEHPBG@ LRLM>F <:EE>= (14+. :G= M>LM>= BM >QM>GLBO>ER HG MA> BKBMBLA IHNG=/1/ =HEE:K I:BK. *HP P> :K> @HBG@ MH <A><D MABL MK:=BG@ EH@B< HG HMA>K F:KD>ML. 3> PBEE HNMEBG> AHP MABL LMK:M>@R PHKDL HG O:KBHNL ;HG= F:KD>ML :G= AHP MH NL> BM MH <HGLMKN<M KH;NLM IHKM?HEBHL.8

3.1 Idea
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

)HK> BG?HKF:MBHG :;HNM MABL MHIB< <:G ;> ?HNG= BG 7168.

221

Trading Systems

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e+-".& '(' da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

222

Appendix 3: Portfolios with the LUXOR trading system

3.2 The trading logic


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

3.3 Results in the bond markets


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

223

Trading Systems

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

3.4 Diversification with other market groups


$>K>, MH LM:R PBMA HNK MK>G=-?HEEHPBG@ EH@B< :G= MH @>M : ;>MM>K ?>>EBG@ ?HK BM, P> ;NBE= : LF:EE IHKM?HEBH H? =B??>K>GM F:KD>M @KHNIL. 3> NL> MPH ;HG= F:KD>ML, MA> #>KF:G BNG= :G= MA> 1/ 0-*HM> (10 R>:K) ;NM :== HMA>K F:KD>ML ?KHF =B??>K>GM F:KD>M @KHNIL: MA> >NKH/=HEE:K :L : <NKK>G<R, MA> )BGB /&, :L : LMH<D BG=>Q IENL #HE= :G= (B@AM CKN=> HBE :L ?:FHNL <HFFH=BMB>L. /H P> A:O> : IHKM?HEBH BG PAB<A MA> LN<<>LL?NE ;HG= F:KD>ML LMBEE ;NBE= MA> <HK> ;NM PAB<A BL =BO>KLB?B>= PBMA

224

Appendix 3: Portfolios with the LUXOR trading system

E>LL <HKK>E:M>= F:KD>ML. %M BL BFIHKM:GM MH F>GMBHG A>K> MA:M MA> )BGB /&, IKH=N<>L : G>@:MBO> >JNBMR EBG>, MA> #HE= @H>L CNLM LB=>P:RL :G= MA> >NKH/=HEE:K P>:D>G>= BG MA> E:LM 3 R>:KL :L P>EE (MA> >JNBMR EBG>L :K> GHM LAHPG A>K>). !O>G PBMA MA>L> F:KD>ML BG<EN=>= MA> HO>K:EE IHKM?HEBH LAHPL : LM>:=R NIP:K= >JNBMR EBG>, LBG<> MA> MPH ;HG= F:KD>ML :G= MA> <KN=> HBE D>IM MA> IHKM?HEBH KNGGBG@ P>EE. 0A> >JNBMR EBG> =H>L GHM EHHD :L LM>:=R :L ?HK MA> <HFIE>M> ;HG= IHKM?HEBH, ;NM MA:M[L PA:M P> >QI><M>=. 0A> B=>: A>K> BL MH A:O> : IHKM?HEBH H? E>LL <HKK>E:M>= F:KD>ML BG PAB<A MA>K> :K> :EP:RL HG> HK MPH MA:M A:O> ;B@ @:BGL MA:M <HFI>GL:M> MA> EHLL>L H? HMA>K F:KD>ML. (>M[L A:O> : EHHD :M MA> IHKM?HEBH[L F:BG ?B@NK>L (0:;E> A3.1). 0A> LRLM>F ?B@NK>L PAB<A P> @>M :K> MRIB<:E ?HK : MK>G=-?HEEHPBG@ LRLM>F. +GER 37% H? :EE MA> 3168 I>K?HKF>= A:O> ;>>G IKH?BM:;E>. 0A> HO>K:EE ;B@ @:BGL H? MA> LRLM>F K>LNEM ?KHF MA> AB@A K:MBH H? :O>K:@> PBG/:O>K:@> EHLBG@ MK:=> PAB<A BL G>:KER 2.5. A O>KR BFIHKM:GM ?:<M MH F>GMBHG BL MA> ?HEEHPBG@: MA> LRLM>F[L @:BGL K>LNEM>= ?KHF MA> 63 IHLBMBO> HNMEB>K MK:=>L. 0A>L> HNMEB>KL IKH=N<>= FHK> IKH?BM ($606.487) MA:G MA> ?BG:E MHM:E G>M IKH?BM ($526.259)! 0ABL F>:GL MA:M MA> >QMK>F> ;B@ PBGGBG@ MK:=>L F:=> MA> IKH?BM H? MA> LRLM>F. 0ABL NG=>KEBG>L :@:BG AHP BFIHKM:GM BM BL BG MK>G=-?HEEHPBG@ LRLM>FL MH E>M MA> IKH?BML KNG. %? RHN FBLL>= MA> IHLBMBO> HNMEB>KL RHN PHNE= A:O> GH @:BG :M :EE. 0A> :GGHRBG@ IHBGM ?HK RHN :L : MK:=>K BL, AHP>O>K, MA:M LN<A ;B@ @:BGL H<<NK O>KR L>E=HF, ;NM PA>G MA>R =H H<<NK, RHN FNLM <:M<A MA>F. AG BGM>K>LMBG@ ?:<M H? MA> LRLM>F BL :ELH MA:M MA> :O>K:@> MBF> BG PBGGBG@ MK:=>L BL FHK> MA:G ?HNK MBF>L EHG@>K MA:G MA> :O>K:@> MBF> PAB<A MA> LRLM>F LM:RL BG EHLBG@ MK:=>L (25 =:RL O>KLNL 6 =:RL). 0ABL LAHPL :@:BG AHP MA> MK>G=-?HEEHPBG@ EH@B< <NML MA> EHLL>L LAHKM :G= E>ML MA> IKH?BML KNG.

3.5 Conclusion
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

225

Trading Systems

PHKD MHH P>EE BG ;HG= F:KD>ML MH GHM NL> MA>F. 0A>R :K> : D>R I:KM BG MA> FHLM LN<<>LL?NE >QBLMBG@ A>=@> ?NG=L. %G HNK HIBGBHG MA>R LAHNE= ;> :M E>:LM HG> <HFIHG>GM H? RHNK MK:=BG@ LRLM>FL B? RHN P:GM MH ;> LN<<>LL?NE BG MA> EHG@ KNG.
Figure A3.1: Equity Lines of 12 major bond markets, in points. Conversion from point values to base currency: German Bund: 1 point = 1000 euro; US T-Bond, US T-Note (10 year) and US T-Note (5 year): 1 point = $1000; US T-Note (2 year): 1 point = $2000; Eurodollar (3 month) 1 point = $2500; Long Gilts: 1 point = 1000; Canadian Government Bond (10 year): 1 point = C$1000; Canadian Bankers Acceptance (3 month): 1 point = C$2500; Japanese Government Bond (10 year): 1 point = 10000 yen; Australian Bond (10 year): 1 point = AU$1000; Korean Government Bond (3 year): 1 point = 1 million. Korean won. End of test period in all markets: April 2006. Charts created with TradeStation 2000i.

226

Appendix 3. Portfolios with the LUXOR trading system

227

Trading Systems

228

Appendix 3: Portfolios with the LUXOR trading system

229

Trading Systems

230

Appendix 3: Portfolios with the LUXOR trading system

231

Trading Systems

Figure A3.2: Portfolio of 12 combined bond-markets. The system equities in points of the following markets were summarised: German Bund, Long Gilt, US T-Bond (30 year, electronic), US T-Note (10 year, electronic), US-T-Note (5 year, electronic), US-T-Note (2 year, electronic), Eurodollar (3 month, electronic), Canadian Government Bond (10 year), Canadian Bankers Acceptance (3 month), Australian 10 year Bond, Japanese Government Bond (10 year), Korean Government Bond (3 year). August 1977-April 2006. Chart created with RINA Systems.

232

Appendix 3: Portfolios with the LUXOR trading system

Figure A3.3: Portfolio of 2 bond markets and 4 markets of different groups: German Bund, US T-Note (10 year), Mini S&P, Gold, Light Crude Oil, euro/dollar. $30 slippage and commissions per trade subtracted. May 1972-April 2006. Chart created with RINA Systems.

233

Trading Systems

Table A3.1: System figures for the 6-market portfolio consisting of German Bund, US T-Note (10 year), Mini S&P, Gold, Light Crude Oil, euro/dollar. May 1972-April 2006. All numbers are calculated with $30 slippage and commissions per trade.

System Analysis Net Profit Gross Profit Gross Loss Percent profitable Ratio avg. win/avg. loss Annual Rate of Return Return on Initial Capital Return on Max. Drawdown $526,259.20 $1,620,546.45 ($1,094,287.25) 37.59% 2.46 1.90% 87.71% 1337.42%

Total Slippage & Commission Profit factor

$95,040.00 1.48

Sharpe Ratio

0.92

Total Trade Analysis Number of total trades Average trade Outlier Trades Positive outliers Negative outliers Total outliers 3,168 $166.12 Total Trades 63 4 67 Profit/Loss $606,487.35 ($24,871.00) $581,616.35

Time Analysis Percent in the market Longest flat period Avg. time in trades Avg. time between trades Avg. time in winning trades Avg. time between winning trades Avg. time in losing trades Avg. time between losing trades Equity Curve Analysis Avg. time between peaks (days) Maximum Equity Drawdown (daily) Date of Maximum Drawdown 73.32 ($39,348.75) 13/12/2000 86.51% 24 12.95 0.48 24.92 2.27 5.74 2.67

234

Bibliography
718 728 738 748 758 768 778 788 798 /MKB=LF:G, 0AHF:L, T&adi#g S,'(e"' Tha( W$& ()<#K:P-$BEE ,KH?>LLBHG:E, 2000). AKHGLHG, :OB=, E*ide#ce-Ba'ed Tech#ica! A#a!,'i' (3BE>R, 2006). 5HN, K. AE>Q, AMMI://>ELF:K.<HF/I=?9?BE>L/ >@K>>L9H?9"K>>=HF.I=? ,:K=H, .H;>KM, >LB@G, Te'(i#g a#d O%(i"i-a(i$# $f T&adi#g S,'(e"' (3BE>R, 1992). &:>DE> & 0HF:LBGB, XCA:GG>E BK>:DHNM W ,:KM 4: (B@AM CKN=> +BEY, T&ade&' (2008). /MKB=LF:G, 0AHF:L, T&adi#g S,'(e"' a#d M$#e, Ma#age"e#( (3BE>R, 2003). CHEEBGL, AKM, Ma& e( Bea(e&' (0K:=>KL ,K>LL, 2004). &:>DE> & 0HF:LBGB, X0A> BFIHKM:G<> H? MBF> ?HK LAHKM-M>KF MK:=BG@Y, T&ade&' (*HO>F;>K 2006). /P>>G>R, &HAG, Ma+i")" Ad*e&'e E+c)&'i$#: A#a!,-i#g P&ice F!)c()a(i$#' f$& T&adi#g Ma#age"e#( (3BE>R, 1997).

7108 ":KK>EE, CAKBLMHIA>K, Z)HGM> C:KEH FH=>EL LBFNE:M> :EE DBG=L H? L<>G:KBHL[, B)'i#e''Wee (2001). 7118 3BEEB:FL, (:KKR, The Defi#i(i*e G)ide ($ F)()&e' T&adi#g, V$!)"e II (BKHPG CH, 1990). 7128 2BG<>, .:EIA, P$&(f$!i$ Ma#age"e#( F$&")!a': Ma(he"a(ica! T&adi#g Me(h$d' f$& (he F)()&e', O%(i$#' a#d S($c Ma& e(' (3BE>R, 1990). 7138 &HG>L, .R:G, The T&adi#g Ga"e: P!a,i#g b, (he N)"be&' ($ Ma e Mi!!i$#' (3BE>R, 1999). 7148 &:>DE> & 0HF:LBGB, XBHEEBG@>K B:G= /RLM>FY, T&ade&' (2006). 7158 &:>DE> & 0HF:LBGB, X0A> 0KB:G@E> /RLM>FY, T&ade&' (2007). 7168 &:>DE> & 0HF:LBGB, X0K>G= ?HEEHPBG@ BG MA> ;HG= F:KD>ML, ,:KM 1 :G= 2Y, T&ade&' (2006).

235

Index

A
:<<HNGM LBS> 165-6, 169 Ac-"/e T+ade+ (F:@:SBG>) 9 :E@HKBMAFB< MK:=BG@ 3-4, 9, 192, 195 AKHGLHG, :OB= 111, 115, 121 :NMHF:M>= MK:=BG@ 3-4 :O>K:@> MBF> BG MK:=>L 31-2, 46, 207, 225

<HLM H? MK:=BG@ (L>>: MK:=BG@ <HLML) <NKK>G<R F:KD>M, :MMK:<MBHGL H? 37 <NKO> ?BMMBG@ 20, 108, 144-5, 158, 204, 213, 223 (L>> :ELH: HO>K-HIMBFBL:MBHG) X<NM EHLL>L LAHKMY 46, 225

D
=>@K>>L H? ?K>>=HF (=?) 15-18, 24, 115, 127, 155 =>?BGBMBHG 16 =>M>KFBG>= (:IIKH:<A MH MK:=BG@) 195 =BL<K>MBHG:KR MK:=>K(L) 5-6, 9, 183, 210, 212

B
;:<D-M>LM 15, 46, 50, 60, 108, 155 ;E:<D LP:G QBB, 189 BH<<:, ":;KBSBH 190-1 BHEEBG@>K B:G= LRLM>F 115-120, 201-7

E
!:LR (:G@N:@> 10, 39-40, 41, 202-3 >JNBMR EBG> <KHLLHO>K 180, 188-190 >QBML (L>> :ELH: LMHI EHLL(>L)) :G= FHG>R F:G:@>F>GM 83-6 =>M>KFBGBG@ :IIKHIKB:M> 64-86

C
<H=> 145, 221 BHEEBG@>K B:G= LRLM>F 117, 203 <HGLMBMN>GM I:KML H? 41 >Q:FIE> 4 BFIHKM:G<> H? 111, 193-5 (14+. 39-40 HIMBFBLBG@ 19, 148, 150 <HFFBLLBHG (L>>: MK:=BG@ <HLML) <HFIE>QBMR (L>>: IHERGHFB:E <NKO> ?BMMBG@ :G= MK:=BG@ LRLM>FL, <HFIE>QBMR)

F
?BQ>= ?K:<MBHG:E FHG>R F:G:@>F>GM (L>>: FHG>R F:G:@>F>GM, ?BQ>= ?K:<MBHG:E) "+.!4, =:BER OHENF> 59 ?NG=:F>GM:E :G:ERLBL 10, 187 ?NMNK>(L) 10, 13-14, 121, 185, 196, 204, 211, 223 F)()&e' (F:@:SBG>) 9
237

Trading Systems

G
#:NLLB:G =BLMKB;NMBHG 105-106, 109-110

M
)A! (L>>: ):QBFNF A=O>KL> !Q<NKLBHG) F:KD>M ;B:L (L>>: F:KD>M =:M:, ;B:L) F:KD>M =:M: 12, 87, 122-6, 145 :<<NK:<R 12-3 ;B:L 46, 112-5, 119, 122-6 O>G=HKL 12-13, 15, 196 F:KD>M LMKN<MNK> 99, 121, 148, 155-7 F:MA>F:MB<:E >QI><M:G<R 29, 160 ):QBFNF A=O>KL> !Q<NKLBHG ()A!) 6670, 76-7, 79, 84 NLBG@ MH =>M>KFBG> LMHI EHLL>L 68-70 F:QBFNF =K:P=HPG 96 (L>> :ELH: FHG>R F:G:@>F>GM, F:QBFNF =K:P=HPG) 163-8 ):QBFNF ":OHNK:;E> !Q<NKLBHG ()"!) 769, 84-6 )>M:/MH<D 10 F>MAH=HEH@B>L, LNFF:KR H? 196-7 )"! (L>>: ):QBFNF ":OHNK:;E> !Q<NKLBHG) FHG>R F:G:@>F>GM 3, 5, 10, 53, 83-6, 87, 145, 159, 160-2, 175, 184, 197 ?BQ>= ?K:<MBHG:E 164-8, 169-170, 173 ?BQ>= K:MBH 168-174 F:QBFNF =K:P=HPG 163-8 FHG>R F:G:@>K(L) 5, 43 )HGM> C:KEH :G:ERLBL 101-110, 173-5, 196 :IIEB>= MH : MK:=BG@ LRLM>F 107-110 EBFBM:MBHGL 108-110 PHKLM <:L> L<>G:KBHL 107-8 FHOBG@ :O>K:@> <KHLLHO>K 19, 24, 41, 43, 183, 197 :O>K:@> MK:=> 28, 55, 58, 122 =K:P=HPG 31-2 I>K<>GM:@> H? IKH?BM:;E> MK:=>L 28-30, 45 IKH?BM ?:<MHK 30, 160 .%*A %G=>Q 32-3 MBF> :O>K:@>L 31-2

H
ARIHMA>MB<-=>=N<MBO> F>MAH= 8

I
BG=B<:MHK(L) 27-32, 145, 186, 210

BGMK:=:R MBF> ?BEM>K 59-64 MK:=BG@ 11-12, 15, 20, 21, 59-64, 66, 149, 190-1 BGLMBMNMBHG:E MK:=>K(L) 5, 15, 182

J
&HG>L, .R:G 168, 169

L
XE>M IKH?BML KNGY 46, 225 E>O>K:@> 10, 160 EHG@ F:KD>M ;B:L (L>>: F:KD>M =:M:, ;B:L) (HG@-0>KF C:IBM:E ):G:@>F>GM 109 EHLL =B:@HG:E 69-70 (14+. MK:=BG@ LRLM>F, <H=> 39-40

238

Index

N
G>M IKH?BM/F:QBFNF =K:P=HPG K:MBH (*,/ ) 71, 74, 75

IKH?BM M:K@>M 76-84 ILR<AHEH@R, ;>ABG= MA> F:KD>ML 29, 158, 221-2

O
HIMBFBL:MBHG 19-24, 26, 49-59, 79, 90, 115, 118-9, 126-135, 147-158, 196 =>?BGBMBHG 19 BFIKHOBG@ >JNBMR EBG>L :G= 131-3 HNM-H?-L:FIE> =:M: 90, 147, 149-150 =>M>KBHK:MBHG 121-2, 129, 135 I>KBH= 21, 22 M>LM 23, 100, 126, 148, 151, 153, 156, 157, 159 HO>K-HIMBFBL:MBHG 23, 108, 194, 196 (L>> :ELH: <NKO> ?BMMBG@)

Q
JN:GMBM:MBO> ?BG:G<> 4-5 F>MAH=L 4 M><AGB<:E :G:ERLBL 8 MK:=>KL 5 MK:=BG@ 5, 181, 183, 193, 195 XJN:GMLY 4

R
.:<H, CKBLMB:GH 190-1 K>M:BE MK:=>KL 5, 11 .%*A /RLM>FL 32-3, 52, 54-6, 180 KBLD F:G:@>F>GM (.)) 3, 5, 10-11, 64-86, 87, 145, 159, 161, 164, 197 .) (L>>: KBLD F:G:@>F>GM) KNE> <HFIE>QBMR 15-16, 134-5, 136, 142, 196

P
I>KLBLM>G<> 195 IHERGHFB:E <NKO> ?BMMBG@ 136-144 IHKM?HEBH(L) ;NBE=BG@ 3, 5, 31, 179-192, 180-2, 184, 185, 197, 212-3, 224 >JNBMR EBG> <KHLLHO>K 180, 188-190 P:ED ?HKP:K= :G:ERLBL :<MBO:MHK 190-1 <HGLMKN<MBHG (L>>: IHKM?HEBH(L), ;NBE=BG@) <HKK>E:MBHG :G= 181-182 F:G:@>F>GM 3 MK:=BG@ 183 IHLBMBHG LBSBG@ 162, 164, 168-9

S
L:FIE> LBS> 29, 155-6, 158 L>E><MBHG PBMAHNM K>IE:<>F>GM 103, 108 LAHKM F:KD>M ;B:L (L>>: F:KD>M =:M:, ;B:L) LEBII:@> (L>>: MK:=BG@ <HLML) LH?MP:K> 3-4, 87, 90, 179-180, 181 EBLM H? :O:BE:;E> 180 M><AGB<:E :G:ERLBL 5 0K:=>/M:MBHG 8 90

239

Trading Systems

LM:;E> BGINM I:K:F>M>KL 49-58 /0A (L>>: /MK:M>@R 0K:=BG@ :G= >O>EHIF>GM CEN;) LMHI EHLL(>L) 69-75, 79, 85, 184 IKH?BM M:K@>M 76-84 MK:=BG@ ?B@NK>L PA>G NLBG@ 82 MK:BEBG@ LMHI 74-5, 77, 79, 85-6 /MK:M>@R 0K:=BG@ :G= >O>EHIF>GM CEN; (/0A ) 10, 38, 39-40, 86 /MKB=LF:G, 0AHF:L QBB, 182, 183, 195 LN<<>LL 5, 87, 111, 160, 183-4, 188, 193, 195, 197 /P>>G>R, &HAG 66, 76

LRLM>F(L) ;:LB< >Q:FIE> 4 BHEEBG@>K B:G= LRLM>F 115-120, 201-7 <HFIE>QBMR 134-5 (L>> :ELH: IHERGHFB:E <NKO> ?BMMBG@) =>?BGBMBHG 3 =>O>EHIF>GM, LM>I ;R LM>I =B:@K:F 87 ?:KF, BFIHKM:G<> H? E:K@> LBS> H? 194 EBFBM:MBHGL 6 LA:KBG@ 121, 194-5 MKB:G@E> LRLM>F 209-220 MKB:G@NE:K FHOBG@ :O>K:@> (0)A) 38

T
M><AGB<:E :G:ERLBL 5, 7, 8, 179, 181 H;C><MBO> 7 LN;C><MBO> 7, 8 Tech#ica! A#a!,'i' $f S($c ' & C$""$di(ie' (F:@:SBG>) 10 Tech#ica! A#a!,'(, 0A> (F:@:SBG>) 10 MBF>L<:E> :G:ERLBL 90-100 0)A (L>>: MKB:G@NE:K FHOBG@ :O>K:@>) T&ade&' (F:@:SBG>) 9, 201 0K:=>/M:MBHG 10, 11, 32 (L>> :ELH: LH?MP:K>, 0K:=>/M:MBHG 8) ?HKNFL 10, 156 MK:=BG@ <HLML 27, 47, 71, 192 F>MAH=HEH@R 4 LMK:M>@R 17, 92, 159, 160 =>?BGBMBHG 3
240

U
NG=>KP:M>K >JNBMR EBG> 31

V
2BG<>, .:EIA 164, 169

W
P:ED ?HKP:K= :G:ERLBL (3"A) 21-3, 149155, 157-8, 190-2 :G<AHK>= 21, 22, 149, 150 KHEEBG@ 21, 22, 149-151, 157 P:ED ?HKP:K= >??B<B>G<R K:MBH 22, 190 P:ED ?HKP:K= M>LMBG@ (L>>: P:ED ?HKP:K= :G:ERLBL) 3"A (L>>: P:ED ?HKP:K= :G:ERLBL) 3BEEB:FL, (:KKR 6, 163

Every day there are traders who make a fortune. It may seem that it seldom happens, but it does as William Eckhardt, Ed Seykota, Jim Simons, and many others remind us. You can join them by using systems to manage your trading. This book explains exactly how you can build a winning trading system. It is an insight into what a trader should know and do in order to achieve success in the markets, and it will show you why you dont need to be a rocket scientist to build a winning trading system. There are three main parts to Trading Systems. Part One is a short, practical guide to trading systems development and evaluation. It condenses the authors years of experience into a number of practical tips. It also forms the theoretical basis for Part Two, in which readers will find a step-by-step development process for building a trading system, covering everything from initial code writing to walk forward analysis and money management. Part Three shows you how to combine a number of trading systems, for all the different markets, into an effective portfolio of systems. A trader can never really say he was successful, but only that he survived to trade another day; the black swan is always just around the corner. Trading Systems will help you find your way through the uncharted waters of systematic trading and show you what it takes to be among those that survive.

Urban Jaekle holds a diploma in physics. He is a regular speaker at the main European trading events and contributes to Traders' and Active Trader magazine. His main business is to provide trading systems' advisory services for hedge funds and institutional investors mainly with automated trading systems, portfolio optimisation and money management solutions. Emilio Tomasini is a proprietary trader for many European banks and hedge funds and Adjunct Professor of Corporate Finance at the University of Bologna, Italy. His website is .
ISBN 978-1905641796

Hh

Harriman House

34.99

9 781905 641796

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