Лекция: A Reality Check

This section sounds a note of warning before you proceed: Test results are not what they seem. You should recognize that trading systems are designed with the benefit of hindsight. This is true because you know, a priori, what the market has done in the past. Any trading system you de­sign or optimize reflects your view of past market action. You may state your understanding in a generalized way that avoids the dangers of

72 Foundations of System Design

curve-fitting. However, it is worth recognizing that the influence of hindsight is difficult to eliminate.

It is also important to recognize that past price patterns may not repeat in precisely the same way. Hence, because the exact future se­quence of trades is unpredictable, your system may not achieve profits or losses similar to the hypothetical system. It should be easy to conclude that past results are not indicative of future results because neither mar­ket action nor trader reaction is predictable.

There is another key problem area with simulated trades. Hypo­thetical trades from a trading system design exercise have not been en­tered in the markets and do not represent actual trading. They do not accurately reflect the effects of market liquidity, slippage, bad fills, over­night trading, or fast markets. They also do not reflect a trader's psy­chology accurately since each and every signal is assumed to be executed with identical simplifying assumptions.

You, the trader, are perhaps the most capricious variable in the trad­ing system. Because system testing is performed in an emotional vacuum, there is no assurance that you will execute all signals from a trading sys­tem without deviation. Thus, the biggest slippage could occur not in the markets, but at the source if you fail to enter orders as required.

As you will see in chapter 8 on data scrambling, it is possible to en­counter market conditions that generate a long string of losing trades or one huge loss. Just because the probability that an event occurs is very small, this does not mean that it will not occur. The usual distribution of trades from a typical trading system has «fat» tails. This simply means that the probability that unusual market conditions will occur is much greater than you might expect from a normal distribution. Hence, sys­tem testing results will often underestimate market risks.

Thus, when you design trading systems, be aware that your hypo­thetical results do not accurately predict system performance in the fu­ture. In general, you should view any trading system results with all due caution.

Chapter

Developing New Trading Systems

Don't count your chickens until they are incubated.