Sunday, May 3, 2009

How to test a trading system

Mind Without Fear, asked a question on trading systems :
Quote
I am trying to answer a slightly different question and I seek your help in trying to figure out what could be the right approaches to address it.
You see I am using essentially a 2MA difference system. Back testing suggests it is profitable over the 6 month period.
I am wiling to try it out for myself at this point.And that brings me to the question. How can I set up a process to detect whether the 2MA system will still be relevant over the next year or two years?
In other words, If I assume that the system that worked for the last six months might degrade over the next year, how can I detect such a degradation as early as possible?
UnQuote

Before actually using a trading system, it should unergo a test. I created a video on this topic with a commentary, (the video cannot be seen since google rendered it in a small frame, but the commentary is easy to understand). You can hear it Now

The main question was: how to detect a degradation in the system ? The way to do this is: determine the three or four important parameters for the system. Identify a cutoff point for these parmeters. In actual trading, if the system begins to go below the cutoff points, you have to relook at the system and accept the fact that the environment may have changed. One way is to calculate the maximum loss incurred till date. In actual trading, if the loss exceeds twice the recorded maximum, then a relook is neccessary.

1 comment:

Mind Without Fear said...

Fascinating! Thank you, Sir.

Regards, ....