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This is one of the more common reasons to hedge - extract alpha and reduce volatility. In any case this is why we do it. IF the strategy has enough alpha this will reduce market risk and result in higher sharpe ratios. You can always add risk by leveraging, so if the strategy is any good you...

We use 20% as the limit when to abandon a strategy. Since we size using LSP (Ralph Vince's method) we actually use 10% risk of hitting 20% drawdown in the next year as the risk level. This is based on the assumption that future returns will be same as walk-forward and real trading results...

One obvious reason why this question is asked is simply that it is trivial to create an optimized trading system with spectacular back-test results (or rather results based on training data). The brutal truth is that almost ANY model combined with a powerful optimizer will show good back-test...

The problem is not constrained to evolutionary algorithms (and generally there is no requirement on the fitness function being a monotone function). I think all optimization/classification algorithms require some structural information to guide the search. Traditional algorithms often use the...

OK, then we're in agreement :)

Totally with you on this one. No matter how you come up with a system with a perceived edge it can be by chance. Many seem to think that just because they found a system "manually" it is not "fitted". What makes it harder for us that rely on ML is that we need to understand not only the...

Totally agree, except for the part on neural networks. We use them extensively for classification and they work fine (even better than SVM in our case). But, many people that try them seem not to understand what they do and how to train them (not that I try to say that you don't).

We have found that using VWAP (or TWAP) when creating systems helps us remove some of the tendencies to overfitting to data. The argument behind this is that, provided that you believe that the price generating process includes a random component, the VWAP price gives you a more stable sample of...

Yes, you should always consider how transaction costs affect the overall result. But, the total impact will depend on your rebalancing interval. Also, depending on the type of strategies involved, the average holding time for a position may affect how you implement the rebalancing.

Good advice all of them. What to do depends on how much work you want to put into this. Regarding sampling errors you may try to use a longer sampling interval to improve the "signal-to-noise" ratio. Or use VWAP prices, depending on what you're trading. This could remove some of the noise...

No good answers on this one I’m afraid. This is obviously just speculation but maybe it could have to do that different strategies run by the big boys feed on one another so that the edge will come and go depending who is currently stronger. Which means it is hard to target a certain edge...

Agreed, definitely. We've been told by a (successful) hedge fund manager that what we do will not work because it is data mining/optimization/overfitting, but still it seems to work. A sound selection process can improve your results significantly, but defining this process seems to be as...

For our oldest running stock trading system, a long only mean reversion system that’s been running from 2006 and forward, we have a hit-rate of 61% over ~2100 trades. We define a hit as making excess market profit (since this makes comparisons easier between different trends and fits the way...

We don't trade volatility (yet) but for our stock trading systems we have seen small negative skew (but this is actually varying over time - negative for 2006 and 2008, positive for 2007, 2009) and quite large excess kurtosis (~3). The large kurtosis is why we put in quite some effort to try to...

OK, I can understand that in some cases you could argue that selection is allowed using out-of-sample trades, but I would require a lot more information on the individual patterns to do that. But, wouldn't you agree that if an out-of-sample test for all patterns shows that the edge...

Actually I agree with this, but it does not give much help in creating a systematic stop-loss rule. For example news works both ways, i.e. you may gain from them or lose. On average news will probably be close to neutral for your expected return. Also, if volatility increases...

I'm with MGJ here. Maybe it’s my cautious nature but I would be very careful using result from out-of-sample tests result to select patterns to use in real trading. What you really want to achieve with the out-of-sample testing is to see whether the APS system gives you patterns that really...

We have also seen this for mean reversion systems. We have tested a large number of stop-loss schemes and failed to find one that improves profitability (expected return increase) in walk-forward testing. This obviously does not mean that they can't be found. Moreover, a stop-loss will...

Most of the times these question seems to be asked in order to find out if there exist a tool that gives you the holy grail trading system. So far I haven’t seen such a tool. Even so, I find neural networks useful. But, as with all tools, you need to understand what it does and how it does...

Mike, I think it is possible but there are some things to keep in mind. Even if you change the information in the joint prob tables LSP will, in its drawdown simulation, combine "disaster" returns with the unaltered returns so the end result will be hard to interpret. We did some analysis...